Large-cap stocks are usually seen as safe bets in periods of volatility, but a large number of Wall Street professionals believe that small companies look increasingly attractive as recession risks grow. Small-cap stocks often received less love compared to their larger counterparts due to the former’s perceived earnings volatility, greater local bias, and lower visibility. They are often avoided during market volatility in favor of more stable options. But history suggests that investors may be wrong. “Historically, downturns have tended to be good buying opportunities for small businesses,” Laurie Calvasina, head of US equity strategy at RBC Capital Markets, said in a note dated July 22. “It also seems to us that small businesses are already baking a lot of economic pain.” The brokerage believes that stocks of small companies are “too close” to prices in the recession, which can be seen “fairly clearly” in the valuations. She noted that small cap stocks now look historically cheap compared to their large cap stocks, with the small-cap Russell 2000 index trading in a price-to-earnings range that “tends to mark its bottom.” Small businesses not only outperform in a recession, but they also do so long after the economy has emerged from the throes of deflation, according to Christian Gallebo, chief market strategist at Putnam Investments. He observed that small-cap stocks tended to underperform large-cap stocks in the months leading up to and during the recession, as well as “over the next three years” as the economy emerged from the recession. Citigroup noted that small businesses were the first to weaken as inflationary pressures held in, and thus could now be “the first to recover”. She said valuations of small stocks were “significantly risk-free” and pricing recession fears. “Small trade versus big cap is close to post-financial crisis lows and relative valuation is not far from 20-year lows,” Citi strategists led by Scott Kronert wrote in a note dated July 26. Bank of America’s main stock ideas Bank of America says “a lot has changed” since the beginning of this year, given some developments: Fed policy, geopolitics, market volatility, rampant inflation, and recession fears. “But the volatility and shifts in the system provide opportunities, and we continue to see a favorable backdrop for stock picking,” Bank of America strategist Jill Hall wrote in a recent report. He noted that stocks with defensible profit margins and pricing power have been rewarded in an environment of high interest rates and inflation. The bank likes food-delivery provider DoorDash, which it said is not directly vulnerable to raw commodity and food inflation due to its position as an offshore platform. The bank has a target price of $90 per share, which closed at $72 on Monday, which represents a potential upside of 20%. Bank of America also likes Illinois-based Option Care Health as the home care name least exposed to labor cost pressures. Hall said the company could see further upside as it deploys improved free cash flow. The bank’s price target of $38 per share suggests a potential 11.8% rise to the stock’s closing price of about $34 on Monday. Read more Has the market bottomed out? Here’s what Wall Street has to say after US stocks rebound in July, is the US in recession? This strategist monitors 14 indicators that this FAANG stock is at an “inflection point” — which Florida-based electronics manufacturer Jabil says is also giving it a 33% rise on the list. The company is working to wind down secular growth markets, as well as sectors such as healthcare, which the bank sees as “generally evidence of stagnation.” Its shares closed at about $59 on Monday, which means a 40% increase to the bank’s target price of $82 per share. Bank of America also loves chip maker ON Semiconductor, for its strong transformation potential, superior products, and exposure to electric vehicle hyper-growth trends. The bank attributed the price target to $80, which represents a potential 25% increase to the stock’s closing price of about $64 on Aug. Barclays has also named a large number of small cap stocks over-rated “high conviction” that it believes offer the potential for superior risk-adjusted returns. The bank’s picks include cybersecurity firm CyberArk, biopharmaceutical company Sarepta Therapeutics, and homebuilder Skyline Champion.
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