Bank of America Merrill Lynch analysts also warned that small-cap’s are now highly leveraged and rely on a smooth economic environment. Excluding financial companies, the Russell 2000 Index’s corporate debt was roughly 3.5 times earnings before interest, taxes, depreciation and amortization, or close to all-time highs hit in the early 2000s and above the 1.8 times EBITDA ratio for the S&P 500.
Consequently, in a rising rate environment, it will become harder for small-caps to borrow and repay debt. Leverage is “one of the biggest risks” small caps face over the medium term, Jill Carey Hall, U.S. equity strategist at Bank of America Merrill Lynch, told the WSJ.
Looking ahead, it will be hard to find additional reasons for small-caps to outperform large-caps as strong earnings and tax reforms have already been priced into the market, according to Morgan Stanley analysts.
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