By Senad Karaahmetovic
Bank of America equity and quant strategists see near-term risks for smaller stocks.
Russell 2000 (+0.9 year-to-date) is modestly underperforming the S&P 500 (+2.1% YTD) and BofA strategists warn that the period of underperformance may continue.
"Tighter credit conditions, wider credit spreads and a higher VIX are typically more negative for small vs large caps; bull steepeners have also been the weakest yield curve phase for small vs large," the strategists said in a note.
The global banking crisis is not helping at all, given that the U.S. regional banks consist of 8% of the Russell 2000. This is another factor that is not helping small stocks and Russell 2000.
"Lack of contagion could still support a preference for small>large over a 12mo view for reasons outlined in our prior work/Year Ahead, and the secular case remains intact. But we view tactical caution on small vs large as prudent," they added.
All in all, the strategists urged the bank's clients to stay selective and focused on high-quality stocks and FCF generators.
"For passive investors, we continue to highlight the S&P 600 as higher quality than the Russell 2000, though it has similar regional banks exposure (we prefer large banks/SIFIs to small/ regional banks). The good news: small cap Financials have grown much higher quality vs. historically," they concluded.