BofA Securities is recommending investors seek out small caps in 2023 as a hedge in a declining market, which they view as priced for a "deep recession." The firm expects this part of the market to realize 12% annualized returns over the next ten years.
"We think any further downside would be more limited in small than in large caps, and once the market bottoms, this is usually the most bullish period for small," the analysts wrote in a note dated Nov. 28, adding that they saw the S&P 500 reaching bottom in mid-2023.
BoA said that they see small caps as already being discounted for a "deep recession," while the Russell 2000 (IWM) is poised to realize annual returns of 12% per year over the next decade. In comparison, BofA forecasts the S&P 500 (SP500) posting annual gains of only 5% during the same period.
The bank also noted that small caps outperformed the broader market during three economic downturns in the 70s and 80s, periods that likewise saw the Fed battling high inflation. BofA views stocks in the energy, financials and staples sectors as "best positioned," but urged caution on investing in healthcare stocks.
One downside to small caps, BoA pointed out, is their debt load, which often is linked to short-term or floating rates that could impact operating earnings if rates remain high past 2024. But the bank said it believes such "bad news" is already being priced into certain stocks.