Bull's calling amidst the rubble via BofA

The Russell 2000 forward P/E lowered to 14.2x in March, a new post-COVID low, but with positive signals, as estimates rose faster than prices improved.

The small-cap segment is now the only one that is still cheap, with its forward P/E 7% below average. For long-term investors, valuations today imply healthy ~10% annualized returns over the next decade for the Russell 2000, said BofA analysts.

Energy and Financials continue to top small cap sector framework of BofA (which ranks sectors on relative valuations, estimate revisions, technicals, and BofA analyst sentiment). Materials saw the biggest jump in rank (to #3 from #7), which is also the only small cap sector that looks broadly expensive vs. large cap peers. Health Care and Communication Services continue to rank last, followed by Staples, which saw the biggest deterioration in rank over the previous month.

Small cap energy ranks favorably in BofA's quant work as it offers an attractive free cash flow yield similar to its large cap peers.

Free cash flow to enterprise value (FCF/EV) has been the best stock-selection factor within small caps over the long-run (since 1986), and within the Russell 2000 (ex.Financials/ Real Estate), Energy offers the highest FCF/EV of any sector (6%).

But Energy remains underweight by small cap core, growth and value managers alike. And BofA analysts highlighted in their recent fund performance note, not owning Energy can really hurt investors' performance as its weight in the index has grown.

The yield curve inversion has occurred by the end of March, increasing downturn fears. An inverted yield curve is typically negative for small vs. large cap performance (given the inversion generally indicates market downturns and economy recessions).

One offset factor is one offseting factor that small cap valuations have been pricing in more risks than prior inversions. The relative P/E of small vs. large is cheaper than ahead of any other curve inversion (and by 20%,on avg.), with absolute valuations cheaper as well.

Analysts of BofA stay near-term favorable on small vs. large given momentum in the services recovery.