Russell 2000 Index: Have geopolitical risks already been priced in?

Investing.com — Bank of America Global Research says that recent declines in the Russell 2000 Index suggest that some geopolitical risks may already be reflected in small-cap stock valuations, but further downside could occur if global tensions escalate.

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Bank of America notes that historically, during major macro or geopolitical shocks, the Russell 2000 has averaged an 8% decline, with a median drop of 11%, while the current monthly decline is about 4%. This indicates that the market may have partially priced in geopolitical risks but has not fully digested them.

However, the bank adds that small caps typically recover within about three months after such shocks, suggesting that geopolitical-driven pullbacks are often temporary rather than structural.

From a valuation perspective, small caps remain at historically low levels relative to large caps, with a forward P/E ratio of approximately 0.78 times relative to the Russell 1000, still below long-term averages.

Bank of America also emphasizes that if geopolitical tensions push oil prices higher or increase stagflation risks, small-cap energy stocks could benefit. This sector has historically shown the strongest correlation with crude oil prices and performed best during stagflation periods. Currently, relative to historical levels, this sector is one of the cheapest among small caps.

More broadly, the bank remains optimistic about value stocks within small- and mid-cap stocks rather than growth stocks, noting that value stocks have historically outperformed growth stocks during periods of rising inflation and economic recovery.

Bank of America states that, from a long-term perspective, valuation suggests the Russell 2000 could achieve an annualized return of about 8% over the next decade, surpassing the expected 2% return of large caps.

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