Large caps got more expensive last month, while small cap stocks became cheaper and are now the only segment of the market that is historically cheap, according to research by Bank of America.
Price-to-earnings ratios of small caps decline in June amidst broader market underperformance and a sluggish Russell 2000.
The Russell 2000's forward P/E ratio dropped to 14.7x, emphasizing the sector's historically cheap valuation compared to its long-term average of 15.2x.
The relative P/E of small versus large at 0.71x remains around 30% below the long-term average of 1.0x, with the multiples suggesting 10% annualized returns for the Russell 2000 over the next decade versus 3% per annum for the Russell 1000.
Based on forecasts across Wall Street, analysts anticipate second-quarter earnings for small caps to improve from previous lows but remain in negative territory year-over-year, the BofA research found.
Analysts in general remain cautious about second-quarter earnings growth, projecting a continued negative 10% year-over-year decline, albeit an improvement from previous quarters.
According to the report, expectations for small cap profits to overtake their larger peers have now been pushed back to the fourth quarter, having been expected to begin outpacing large cap profits growth by the second.
"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 (which BofA expects to begin in December)," the report said.
Despite these challenges, opportunities exist within specific sectors. Communication Services emerged as a top-ranking sector, buoyed by favorable valuations and momentum, while Technology lagged behind, facing sector-specific risks.