Now is not the time to get back into small caps, regardless of their recent underperformance, says Steven DeSanctis, strategist at Merrill Lynch in New York, in Thursday’s View of the Day column.This is despite the fact that when the Fed has cut interest rates in the past – as it is widely expected to do next week – small caps have usually delivered strong results and beaten large caps, he adds.

DeSanctis notes that since May 2006, the Russell 2000 has trailed the S&P 500 by almost nine percentage points, an underperformance that he expects will continue.

“The potholes along the road are too many to avoid for the small caps,” he says.

Fed interest rate cuts will not compensate for the weaker fundamentals in the size segment and relative valuations are not compelling in our view. Small caps tend to lag behind when volatility ticks up and credit spreads widen. Large caps will continue to see better earnings growth than the small caps owing to the weakness in the US dollar, better economic growth outside the US, and a slower US economy.

Large caps have 62 per cent of their companies with some sales abroad versus 32 per cent for the small caps. Meanwhile, large caps on average have derived almost 25 per cent of their sales from outside the US borders, which is double the small caps at 12.3 per cent, he notes.