Small-Cap Stocks Have Long-Term Advantage: Bank of America

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Small-cap stock valuations last month hit a 20-year low compared with large caps. And that leaves small-cap stocks poised for stronger gains over the next decade than large caps, according to Bank of America.

The forward price-earnings multiple of the Russell 2000 small-cap index totaled 0.75 times that of the Russell 1000 predominantly large-cap index in December, Bank of America equity strategist Jill Carey Hall said in a commentary Wednesday.

That’s more than 25% below the long-term average of 1.02 times and the cheapest since 2001, she noted.

Just as the “2000s were a strong decade for small-caps despite what was ultimately a negative decade for large-caps, … the Russell 2000 could see high-single-digit annualized returns over the next decade versus low-single-digit annualized returns for the Russell 1000,” Hall said. 

The S&P 500 might even post a negative return for that period, she added.

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So what does Bank of America like among small-cap stocks?

“Top-ranked sectors in our small-cap tactical sector framework remain cyclicals: energy, financials, real estate and consumer discretionary,” Hall said.

“While uncertainty over omicron remains, consumer discretionary multiples appear to be discounting the risks: relative valuation versus the index is already at 2020 Covid lows.”

And that’s true despite the less severe infections stemming from omicron than past strains and a “less dramatic shutdown backdrop,” she said.

The health-care sector lies at the bottom for Bank of America, falling beneath utilities. It put health care last because the industry “ranks poorly in our work, has deteriorated in quality and has seen unfavorable supply/demand dynamics,” Hall said.