RBC: Too early to turn bullish on US small caps

RBC Capital analysts advised caution regarding US small-cap stocks, despite their recent underperformance.

In a note, the investment bank highlights several factors that make the outlook for small caps less promising in the near term.

"The continued outperformance of mega-cap growth stocks has been logical but still somewhat jarring to us," the bank acknowledges. This trend coincides with a decline in Treasury yields, which historically benefited small caps. However, RBC Capital suggests a decoupling is underway.

They attribute the outsized performance of large-cap growth stocks to a combination of factors.

First, slowing GDP forecasts create a more favorable environment for large-cap and growth-oriented companies compared to small-cap and value stocks. Second, recent earnings revisions have been more positive for large caps. Finally, reduced crowding in the large-cap growth sector makes it more attractive.

While acknowledging the recent weakness in small caps, RBC Capital remains neutral on the sector relative to large caps. They recognize the historically favorable positioning of small caps based on investor sentiment and valuation metrics.

However, they caution that these factors are outweighed by the lack of fundamental tailwinds and negative earnings revision trends for small caps.

The report emphasizes a wait-and-see approach. "We see enough that looks interesting to stay neutral for now and think that when it's finally time to put on Fed rate cut trades this space will do well," RBC Capital concludes.

However, they recommend holding off on an overweight position in small caps until the Federal Reserve rate cuts are imminent and economic conditions improve.