5 reasons to own SMID cap Value

BofA Securities is currently favoring value stocks over growth in small- and mid-cap equities. This preference is based on five key reasons. The first reason is an anticipated recovery in earnings per share during the second half of the year. This is because value stocks typically perform well when profits begin to recover. The second reason is value's consistent outperformance in both mid-cycle and hiking regimes.

The third reason cited by BofA is reduced concentration risk, which could benefit the market if leadership becomes more diversified. The fourth reason is higher quality stocks, which are expected to lead in the second half of the year. Lastly, BofA believes value stocks are a better choice within large-cap equities. This is supported by the fact that larger weights in the value benchmark are present in top-ranked sectors such as real estate, financials, and energy.

Additionally, BofA's economists have adjusted their outlook to anticipate three rate hikes this year, following the Federal Reserve's hawkish stance and a robust jobs report. However, a prolonged hiking cycle may pose a significant risk for small caps, given their higher leverage and refinancing risk. The P/E ratio of the Russell 2000, which represents small caps, is currently priced for further deterioration in the ISM manufacturing index, which could negatively impact the recovery in manufacturing.

On a positive note, BofA remains optimistic about small- and mid-cap equities compared to mega-cap stocks, citing stronger earnings recovery expectations, less-stretched multiples, and lower concentration risk. The broker does, however, note that mid-cap equities, which have underperformed small caps year to date, carry a lower risk from Fed rate hikes.