Investing.com -- European small-cap stocks could outperform their larger counterparts, according to Bank of America (NYSE:BAC) (BofA) strategists.
Despite European equities' recent strength, small caps have not kept pace, with their performance relative to large caps at a nine-year low. However, BofA identifies several factors that could reverse this trend and propel small caps ahead.
According to the bank, there are four key drivers that may support European small caps in the near term.
First, the firm anticipates a boost in Euro area growth momentum, which is typically beneficial for small caps. This view is based on easing credit conditions and a reduction in fiscal and inventory drag.
Second, a potential ceasefire between Russia and Ukraine could lead to lower energy prices and reduced uncertainty in Europe, a factor that “would favor small cap outperformance,” strategists said.
Further supporting the case, BofA expects the negative impact of euro weakness on domestically-focused small caps to diminish, contrasting with globally-exposed large caps.
Lastly, the firm predicts that European Central Bank (ECB) easing will result in lower Bund yields. Given the recent inverse relationship between small caps and rates, this “would remove another obstacle to outperformance,” strategists noted.
In line with this outlook, BofA maintains an Overweight position on European small versus large caps and UK domestic companies relative to exporters.
The firm forecasts approximately a 10% outperformance for European small caps over the coming months.
This outlook is part of a broader investment strategy that includes an Overweight stance on European equities relative to global equities, a preference for quality stocks, and an Underweight position on cyclicals versus defensives.
The investment bank's macroeconomic assumptions indicate a potential 10% renewed downside for European cyclicals compared to defensives, following the recent rally.
“We see a particularly attractive entry point for European quality stocks, which tend to outperform when bond yields decline and are currently trading at a five-year low relative to the market, following 7% underperformance over the past year,” the bank concluded.