Communication Services now ranks at the top of Bank of America’s small-cap quantitative sector rankings, boosted by strong sentiment and improved momentum.
"The sector in recent months has also looked historically inexpensive on relative forward P/E for the first time since 2020, and trades at a 30% discount to its typical relative multiple vs. Tech,” strategists said in a note.
Real Estate has climbed to second place from fifth, but its valuation remains less attractive compared to many sectors, and there are ongoing concerns about refinancing risk. Tech remains at the bottom of the rankings, followed by Consumer Discretionary and Health Care.
Analysts expect continued improvement in the profit trajectory for small caps, with 2Q earnings growth for current constituents forecasted at -10% year-over-year, up from -20% YoY in 1Q. However, both growth and the estimate revision ratio remain negative, disappointing relative to earlier expectations that small cap earnings growth would turn positive and outpace large cap profits by 2Q.
"Now, analysts don’t expect small cap profits to turn positive until 2Q and outpace large cap growth until 4Q,” strategists noted.
“As we highlighted last month, Russell 2000 outperformance may depend on more confirmation over the next quarter that estimates for the back-end-loaded profits recovery are reasonable, together with further evidence of slowing inflation to support Fed cuts," they added.
BofA said small caps are currently the only historically cheap size segment. While multiples are generally most predictive over the long-term, current figures suggest a 10% annualized return for the Russell 2000 over the next decade, compared to just 3% per annum for the Russell 1000.