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BofA analyst Jill Carey Hall said in a note to clients on Friday that while near-term caution on small caps is warranted, they would stick with small caps over large caps for now.
“BofA economists forecast a mild recession starting now, with negative q/q GDP growth from 1Q22-1Q23,” said Hall. “Several of the most correlated indicators with small cap returns have been deteriorating (PMIs, consumer/small biz sentiment, leading indicators) and our high yield strategists see further spread widening, though to lower levels vs. prior recessions (HY note). As such, we would be cautious on small caps in the coming months, where we expect volatility and risk of further downside.”
However, Hall explained further that they would double-down on their relative preference for small over large caps.
“Aren’t recessions worse for small caps? Yes – but this time, we think risks are largely discounted, and small caps are better positioned to weather today’s backdrop of higher-for-longer inflation, deglobalization, risks to COVID beneficiaries (big Growth stocks), and geopolitical risks. And small cap corporates have been guiding above consensus (with guidance ratio improving) vs. below-avg./deteriorating guidance in large. Stagflation typically isn’t good for equities, but small caps have outperformed large.”
