Small-cap exchange-traded funds (ETFs) have witnessed their largest weekly inflows since Bank of America began tracking the data in 2017.

According to a note shared Wednesday, this surge is predominantly fueled by retail investors, marking a significant shift in market dynamics.

Over the past 23 weeks, 22 have seen positive inflows, culminating in a record-breaking week that attracted over $3.5 billion into small-cap ETFs.

Data derived from Tradingview shows that the Pacer US Small Cap Cash Cows ETF (NYSE:CALF) has emerged as a frontrunner, drawing in over $3 billion in the last three months, closely followed by the Vanguard Small-Cap ETF (NYSE:VB) with $2.6 billion of inflows, of which $1.615 billion recorded in the last month alone.

Despite this record influx of funds, Bank of America highlights that small caps remain undervalued relative to their historical performance.

Top 10 Small-Cap ETF By Inflows Over The Last Three Months

Small Caps: A Bullish Outlook For 2024

Bank of America's analysis suggests a turning tide for small caps. Analyst Jill Carey Hall, CFA, maintains a bullish outlook, predicting that 2024 could mark the year when small caps outperform large caps for the first time in nearly a decade.

This optimism stems from a resilient small-cap sector, which has priced in a recession that has yet to materialize, as evidenced by the Russell 2000's performance.

With investor sentiment improving and valuations becoming more attractive, small caps present a compelling opportunity for long-term investors. The Russell 2000's forward P/E ratio has dipped to 14.3x, positioning small caps as the only size segment that is historically inexpensive.

According to Bank of America, the valuation gap between small and large caps is reminiscent of the disparity seen during the Tech Bubble, which preceded a decade of exceptional returns for small caps.

Bank of America's analysis implies potential annualized returns of 10% over the next decade for the Russell 2000, compared to a modest 3% for the Russell 1000.

For 2024, Bank of America reinforces the strategy of focusing on value within the small and mid-cap spaces. This approach favors high-quality stocks over non-earners. Financials, Communication Services, and Industrials are identified as top sector overweights within small caps.

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