Regional bank stocks and small cap stocks are severely lagging the broader market, and some money managers say the worst isn't over yet.
The two corners of the market in theory should be reaping the benefits of relatively strong U.S. economic growth, a central bank on the path to further hike interest rates and an increasingly friendly corporate regulatory environment, but they're doing just the opposite.
Regional banks tracked by the KRE ETF just posted an eighth-straight session of losses, the group's longest losing streak since 2016, and has slumped to an eight-month low; small caps tracked by the IWM ETF just sank to a seven-week low, all while the broader markets are in rally mode.
To Chad Morganlander, portfolio manager at Washington Crossing Advisors, the decision is clear.
"Stay away from small caps," he said Tuesday on CNBC's "Trading Nation." He also advised going underweight the Russell 2000 and go overweight in large-cap value stocks.
"We think volatility is going to start picking up as the Fed continues to raise rates and reduce their balance sheet. … Here in the United States, economic growth is quite vibrant over the next 18 months. We're not expecting any real recession, so you just want to be in more consistent, quality companies at this point in the market cycle," Morganlander said.
He also recommends that investors go underweight regional banks, as he does not see the Treasury yield curve — the spread between the 2-year and 10-year Treasury yields, which can often impact the health of banks' balance sheets — steepening meaningfully over the course of the next few months.
Both the KRE and the IWM are trading at critical technical junctures, according to Instinet's top technical analyst, Frank Cappelleri. Both groups are going to need to hold their respective support levels — $164 per share on the IWM and around $58 per share on the KRE — to confirm any meaningful legs higher. He's particularly concerned with regional banks' performance as of late.
"The issue is we've seen oversold bounces before in the KRE, and it hasn't done anything with it," Cappelleri said Tuesday on "Trading Nation," adding it's even more "glaring" that it has not managed to rally in the face of a rising 10-year Treasury note yield.
The KRE closed modestly lower on Tuesday at $58.61, and the IWM closed lower by 1 percent, barely off session lows, at $164.53.