As U.S. stocks rally, Citigroup and JPMorgan like laggards

Strategists at Citigroup and JPMorgan are bullish on U.S. equities as trade tensions ease, encouraging investors to focus on some of this year’s worst performers for potential short-term gains. These include economically sensitive small-cap stocks and shares of companies that slumped on disappointing earnings.

Major U.S. stock indexes have already recovered their year-to-date losses, but Citigroup and JPMorgan strategists are urging investors to look at stocks that lagged the S&P 500 during the recent rally. Over the coming weeks, they are particularly optimistic about small caps, technology hardware manufacturers, and homebuilders, according to Bloomberg.

The outlet also notes that the Goldman Sachs index tracking the 50 most indebted companies has outperformed the S&P 500 in seven of the past eight trading sessions, which suggests that traders are already rotating into cheaper stocks.

Stocks of companies with weak financials are now attractive, says Stuart Kaiser, head of U.S. equity trading strategy at Citigroup. He believes that investors who missed out on the recent rally are now likely to pour capital into lagging segments. “Now, they’re under-positioned and have a lot money to use to buy some of these laggards,” Kaiser explains.

Professional managers have been cutting equity exposure in recent weeks, but the rise in the S&P 500 could pull them back into the market. In addition, traders unwinding bearish bets on the Russell 2000 are likely to further boost small-cap stocks in the weeks ahead, Kaiser adds.

JPMorgan believes it’s now worth buying battered sectors — such as retail or consumer discretionary — via derivatives, in anticipation of a possible short squeeze.

“Any short squeeze will likely push small- and mid-capitalization companies to outperform,” wrote JPMorgan strategists led by Andrew Tyler, as quoted by Bloomberg.

Long-term investors remain cautious on small-cap stocks and companies with weak balance sheets, citing still-elevated interest rates and slowing economic growth, Bloomberg reports. While the broad market rallied this week following a temporary easing in U.S.-China trade tensions, many still fear the conflict could escalate again.

“We’re still not out of the woods on tariffs so we wouldn’t buy small caps or own the riskier parts of the market,” said Thomas Martin, senior portfolio manager at Globalt Investments. “That may work for a short-term trade, but it doesn’t work for those managing money for the next few years.”

Additionally, while small caps were among the key beneficiaries of Trump’s victory in November, one of his key policies — tougher immigration enforcement — could raise labor costs and hurt domestically focused businesses, Bloomberg notes.

Still, the valuation gap between high-quality stocks and more economically sensitive risk assets is now so wide that the latter have much more room to run in the short term, says Dennis Debusschere, founder of 22V Research. “Given how onerous the China tariffs were for small caps, that group has the most near-term upside,” he reckons.