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Bank of America sees small-cap stocks as a leading indicator to watch for the broader stock market.
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High concentration in a few stocks and high valuations are limiting the stock market’s upside, Bank of America said.
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Small-cap stocks face challenges from rising interest rates, which impacts non-profitable companies.
Bank of America He said in a note on Friday that one key area for the stock market will help determine whether the bull run continues.
Michael Hartnett, an investment strategist at the bank, said that while President-elect Donald Trump’s influence and policies can provide a safety net for the stock market, the upside is limited by high concentration in a few stocks, high valuations, and extended positions by investors. Investors.
Hartnett highlighted that a survey of fund managers conducted by the bank in December showed that investors maintain a record overweight position in US stocks.
The key signal for a continued rally, according to Hartnett, is whether penny stocks can rise above a key resistance level set for 2021.
Small stocks briefly broke above resistance after Donald Trump won the election in November, but have since given up the bulk of those gains and are trading just around the resistance level as investors worry about… Interest rates stay higher for longer.
High interest rates are particularly painful for small stocks because they are more sensitive to changes in borrowing costs. About 40% of small companies are included in the Russell 2000 Index unprofitable, Which means that debt financing often plays an essential role in financing their operations.
If the cost of debt rises and stays higher when a company that is making little or no profits is due for refinancing, It can eventually lead to bankruptcy.
According to Hartnett, all systems go if penny stocks can break decisively above the 2021 resistance level. However, if not, it could signal broader market weakness, and asset spreaders are expected to trim their overweight positions in the market. Stocks.
Hartnett recommends investors buy bonds where Treasury yields are likely to peak near the 5% level and interest rate-sensitive stocks, which are often found in the financials, utilities and homebuilding sectors.
Read the original article on Business insider