Stocks are at record highs, but there's an area of the market where investors can still get a great deal, BofA says

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• Stock valuations are stretched but there's a corner of the market that still offers a good deal.
• Small and mid-cap stocks are trading at a discount and could benefit from several tailwinds, BofA said.
• Strategists said that financial stocks in both sectors have a particularly bullish outlook.

The stock market is a hair away from record highs — but there's an area of the market that should stick for investors looking for a deal, Bank of America analysts said.

In a note on Tuesday, researchers said they saw opportunity brewing in small-cap and mid-cap stocks, an area of the market that the bank is bullish on going forward.

The outlook comes as some market pros see valuations in the S&P 500 as stretched to extreme levels. Major indexes are at or hovering near record highs, despite uncertainty around the US economy, the outlook for Fed rate cuts, and the impact of President Donald Trump's tariffs.

The tailwinds for small-caps haven't boosted the sector so far in 2025. The Russell 2000 is up 1.5% year-to-date, lagging behind the S&P 500's 9.6% gain.

But the risk profile going forward looks different for small- and mid-cap stocks. Here are the reasons Bank of America remains particularly optimistic on those two areas:

Small-caps

BofA has previously said it sees small-cap stocks poised to outperform the broader market over the next decade, boosted by a handful of bullish catalysts:

• The sector remains historically undervalued. Small-cap stocks have been lagging behind large-cap stocks for about a decade, and are still trading at a "steep discount," strategists said.
• A handful of bullish themes. The sector is likely to benefit from a handful of tailwinds brewing in the broader economy. Strategists pointed to trends like reshoring, the economy reaching "peak globalization," and talk of a new capex cycle in the US, with firms pouring money into new investments that could benefit smaller companies.
• Profits are coming out of a recession. Earnings for small-cap stocks look like they're finally coming out of a downturn, with the second quarter containing "green shoots" for some small-cap companies in the Russell 2000, the bank said. Earnings growth in the S&P 600, meanwhile, also looks on track to inflect positively in the second quarter.

The bank said was cautious in the near-term on the Russell 2000 index due to risks that the Fed may not cut rates as aggressively as expected this year. The small-caps sector is also still struggling from weak fundamentals and faces lingering risks from tariffs, despite underlying bullish trends, they added.

Mid-Caps

Mid-caps are also shaping up to be a promising area of the market, BofA strategists suggested.

• The sector is also heavily discounted. Relative to large-cap stocks, mid-caps are trading at a forward price-to-earnings ratio of around 0.75. That's the lowest premium on mid-caps relative to large-caps since 2001, the bank said.
• More attractive than small-cap stocks. The bank said it favored mid-cap stocks over small-cap stocks. Companies in the mid-cap sector have better fundamentals, "cleaner" balance sheets, and face fewer risks from tariffs.

The bank added it was particularly bullish on one sector across small- and mid-cap companies: financials.

"Financials continues to rank #1 in our small & mid-cap quant work, based on relative valuations, revisions, technicals, and BofA analyst upgrades vs. downgrades," strategists wrote. "Most mid-cap banks raised net interest income guidance in 2Q and beat loan growth expectations, which may limit deposit cost pressures near-term."

Others on Wall Street have been paying closer attention to smaller companies on the stock market, in part due to lofty valuations among large-cap firms. According to some valuation metrics, the S&P 500 now looks as or more expensive than stocks did during the dot-com bubble, some strategists say.

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