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Investing.com -- Bank of America said investors should “stick with quality Value” stocks, as improving fundamentals and a shift in market regime support a rebound in the style after a challenging third quarter.
In its Small/Mid Cap Factors report, BofA said small-cap value strategies lagged in the third quarter, with value factors lagging “the equal-wtd. index by 1.3ppt,” while “only 10% of small cap Value funds outperformed in 3Q and Sept.”
However, the bank pointed to “multiple signals” suggesting value’s prospects are set to improve.
“The US Regime Indicator recently moved to Recovery, the phase during which Value was the most consistent leader within small caps,” BofA said.
It added that value “has led Growth in Fed cutting cycles and should see support if the recent positive inflection in small cap profits growth and revisions persists (assuming no broad decline in macro or credit conditions).”
BofA also noted that “Value has recently begun to outperform in mid caps.” While growth remains in favor, the firm said “Growth factor leadership in small hasn’t come from secular growth stocks, which lagged the index in Sept. and in 3Q.”
Instead, performance was said to have been driven by margin strength and positive revisions.
The bank cautioned that “the smallest Russell 2000 quintile has outperformed each month since Apr.,” but said “microcaps are the most expensive part of small and typically lag in cutting cycles.”
It concluded that “the low quality rally is in its later innings.”
BofA said its preferred approach remains to “stick with quality Value” amid early signs of improving conditions for active small-cap investors.