Too early to buy Russell 2000, BofA says

Investing.com -- Bank of America (BofA) relayed a cautious stance on the Russell 2000, suggesting it is too early for investors to buy into the small-cap index despite the recent sell-off.

The Russell 2000, which tracks small-cap stocks, has plummeted 25% from its November highs, and its forward price-to-earnings (P/E) ratio has similarly compressed to 13.4 times, marking a 12% decline from the average and the lowest since October 2023.

But despite the correction, BofA strategists believe that the risks are not fully priced in, especially considering potential tariff impacts.

“Since the 1950s, small caps have fallen 35- 40% around US recessions - we’re >60% of the way there, implying upside if recession does not materialize, but further downside risk if the outlook deteriorates further,” strategists led by Jill Carey Hall and Nicolas Woods said in a note.

The bank’s analysis indicates that small caps could see operating income reductions ranging from 22% with no retaliation to a full 100% under bilateral tariffs, compared to less severe impacts on mid-cap and large-cap stocks.

The Russell 2000’s P/E decrease of 23% since late 2024 suggests that market prices may not fully reflect these risks.

Moreover, analysts have only reduced 2025 earnings estimates for the index by 12% since the beginning of 2025, even as they anticipate a decline in first-quarter profits following a brief resurgence in the fourth quarter of the previous year.

BofA recommends a continued preference for mid-cap stocks over small caps, highlighting Financials as the top-ranking sector in their small and mid-cap frameworks.

The sector is seen as well-positioned if a recession is avoided, but the bank advises a defensive strategy in the near term, with Utilities ranking as the best defensive sector in small caps.

On the other hand, energy and materials are the worst-ranking sectors in small caps, compared to Industrials among mid-caps.

“We’d continue to focus on higher quality/profitable stocks with low leverage and better revisions – where Value continues to screen more favorably than Growth,” strategists said.

Despite the short-term outlook, BofA suggests that small caps still offer relative value for long-term investors.

As of April 4, the P/E for the Russell MidCap and Russell 1000 stood at 16.0 times and 19.1 times, respectively. Small caps are trading at a 30% discount relative to large caps, a range that has persisted since 2022.

BofA’s long-term valuation models predict potential average annual price returns of 11% for the Russell 2000 over the next decade, compared to 8% for the Russell MidCap and 5% for the Russell 1000, despite current reservations about the small-cap sector.