‘The canary is coughing’: BofA sees small-cap slump as stagflation warning
The valuation multiple of small-cap stocks is falling, which could signal an economic downturn, BofA warns. / Photo: Bloomberg
U.S. small-cap stocks, one of the riskiest segments of the equity market, are flashing warning signs of a potential slowdown in business activity, Bloomberg reports, citing a note from BoA. Small caps are often the first to react to worsening economic conditions. In this case, the concern is stagflation.
Details
BoA notes that historically the P/E ratio of small caps and the ISM PMI tend to move in the same direction. Now, small-cap valuations are sending a worrying signal about the U.S. manufacturing sector, BoA warns.
BofA estimates current P/E multiples in the small-cap segment imply a PMI reading of 47 points. A level below 50 signals economic contraction. While the PMI remained below 50 from late 2022 through December 2024, it has been above the threshold for the last two months.
What it means for investors
Small-cap companies, which generate 77% of their revenue domestically, are often viewed as the “canary in the coal mine” for economic stress, Bloomberg notes, citing Jefferies. The Russell 2000 index, which tracks 2,000 small-cap stocks, remains firmly in correction territory — down 15% from its 2021 peak and nearly 7% lower since the start of 2025.
This trend should be a red flag for investors worried about stagflation, where economic growth slows while inflation rises, Bloomberg warns. In such a scenario, the U.S.Fed could struggle to respond effectively.
“Right now the canary is coughing and soon might keel over,” says CFRA chief investment strategist Sam Stovall, as quoted by Bloomberg. “This higher-volatility group is likely to surrender its gains more quickly than large caps in the face of a recession.”
BofA’s prediction just that for now — official March PMI data has yet to be released, with ISM set to publish it in early April. The last available reading, for February, stood at 50.3 points.
