Small caps haven't been this cheap compared to large stocks in nearly two decades — How to play it

Published Thu, Apr 9 20208:13 AM EDT

Jesse Pound @/in/jesse-pound @jesserpound

(This story is for CNBC Pro subscribers only). The dramatic market sell-off sparked by the coronavirus has widened the valuation gap between large cap and small cap stocks, and it may be time for investors should take a look at the smaller names, according to Bank of America . Small cap stocks are now at the cheapest on a price-to-earnings basis since 2011, and the cheapest relative to their larger peers in almost two decades, the bank said in a note. And investors may be catching on. As the markets rose on Wednesday, the small cap Russell 2000 index surged 4.6%, easily topping the gain of the index for larger stocks, which rose 3.5%. "On a relative basis, the Russell 2000 is trading at an 18-year low relative to the Russell 1000 (0.8x), and relative valuations for the size segment are cheap vs. history across all six metrics we track," the note said. Investors can bet on small caps in general through exchange-traded funds. The iShares ETF that tracks the Russell 2000 is down more than 28% so far this year, along with the Vanguard Russell 2000 Index Fund . This is well below the roughly 16% decline for the iShares Russell 1000 ETF , tracking larger names. Small caps are generally more domestically focused so they are getting hit especially hard with the coronavirus shutdowns. This gap should set up a winning long-term trade for investors who bet on small caps, but it might be a risky play in the short term, the bank said. "For long-term investors, today's relative P/E suggests that small caps should outperform large caps over the next decade. But for the near-term, we remain cautious given earnings, credit and dividend risks," the note said. Within small caps, different sectors look more valuable than others, according to the bank. Tech and consumer staples are the highest rated small-cap sectors, while energy is the biggest area of concern, according to the note. Health care, financials and utilities small caps are trading at historically expensive levels relative to their larger peers, the note said. ETFs that track small cap sectors are not as widely held as those broader funds listed above, but Invesco does offer one for S & P 600 Information Technology stocks with about $200 million in assets under management. That fund is down about 22% year to date.

New York Stock Exchange building is seen at the Financial District in New York City, United States on March 29, 2020.

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(This story is for CNBC Pro subscribers only).

The dramatic market sell-off sparked by the coronavirus has widened the valuation gap between large cap and small cap stocks, and it may be time for investors should take a look at the smaller names, according to Bank of America.