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Bank of America considers small-cap stocks a key indicator to watch for the broader stock market.
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A heavy concentration on a handful of stocks and high valuations limit the rise in stock markets, BofA said.
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Small-cap stocks face the challenges of high interest rates, which affect profitless businesses.
Bank of America said in a Friday note that a key area of ​​the stock market will help determine whether the bull rally continues.
Michael Hartnett, an investment strategist at the bank, said that while President-elect Donald Trump’s influence and policies could provide a safety net for the stock market, upside is limited by heavy concentration in a handful of stocks , high valuations and tight positioning on the part of some investors. investors.
Hartnett pointed out that the bank’s December fund manager survey showed that investors hold a record overweight in U.S. stocks.
According to Hartnett, the key signal for a continued rally is whether small-cap stocks can break out above a key resistance level set in 2021.
Small-cap stocks briefly broke above the resistance level after Donald Trump’s election victory in November, but they have since given up most of those gains and are trading just around the resistance level as investors worry . interest rates stay high longer.
Higher interest rates are particularly painful for small-cap stocks because they are more sensitive to changes in borrowing costs. About 40% of companies in the Russell 2000 index are small caps are without profit, which means that debt financing often plays a vital role in financing their operations.
If the cost of debt increases and remains higher when a company with little or no profit has debt to refinance, this could ultimately lead to insolvency.
According to Hartnett, all systems go if small-cap stocks can decisively break through their 2021 resistance level. However, failing to do so could signal broader market weakness and he would expect Asset allocators are reducing their overweighting on the stock market.
Hartnett recommends investors buy bonds with Treasury yields that can peak near the 5% level and rate-sensitive stocks often found in the financial, utilities and construction sectors residential.
Read the original article on Business Insider
