Why Underweight Stocks Will Continue To Outperform Overweight Stocks

• BofA Merrill Lynch’s Savita Subramanian said that a midcap bubble seems to be forming, with midcaps now trading near a record premium to large caps.

Analyst Savita Subramanian wrote, “Buying the ten most underweight stocks and selling the ten most overweight stocks by large cap active fund list as of 12/2014 has produced a spread of 10ppt YTD, outperforming the average long-short equity hedge fund performance of -2bp.”

Among the top ten are NetApp Inc. NTAP, Texas Instruments Incorporated TXN and Adobe Systems Incorporated ADBE, while among the bottom ten are Hewlett Packard Enterprise Co HPE and CSRA Inc CSRA.

This strategy has generated positive spreads consistently over the past several years, with outflows from active to passive. This could continue, Subramanian said, explaining that passive funds comprise merely about one-third of the US large cap space.

The analyst stated that active managers had increased their exposure to cyclicals sectors’ allocations, possibly in view of the first Fed rate hike in a decade. The biggest upticks were in Energy, Discretionary and Tech. She added, “Financials has moved from a chronic underweight to neutral, pushing it to a bullish extreme…Energy is still the most hated relative to history.”

Subramanian believes that a midcap bubble is in the making, with mid-caps now trading near a record premium to large caps.

For 2016, the analyst expects underweight stocks to continue to outperform overweight stocks.

Buy-Rated, U/W Stocks

McDonald's Corporation MCD
Exxon Mobil Corporation XOM
NextEra Energy Inc NEE
Ford Motor Company F
AT&T Inc. T
T. Rowe Price Group Inc TROW
Perrigo Company plc Ordinary Shares PRGO
Phillips 66 PSX
Skyworks Solutions Inc SWKS

Underperform-Rated O/W Stocks

Chipotle Mexican Grill, Inc. CMG
Monsanto Company MON
Cummins Inc. CMI
Mead Johnson Nutrition CO MJN
American Express Company AXP
Viacom, Inc. VIAB
General Mills, Inc. GIS
Micron Technology, Inc. MU
Bed Bath & Beyond Inc. BBBY
Corning Incorporated GLW