Financial institution of America sees small-cap shares as key indicator to observe for the broader inventory market.
Excessive focus in a handful of shares and elevated valuations restrict inventory market upside, BofA mentioned.
Small-cap shares face challenges from excessive rates of interest, affecting profitless corporations.
Financial institution of America mentioned in a Friday notice that one key space of the inventory market will assist decide whether or not the bull rally will proceed.
Michael Hartnett, an funding strategist on the financial institution, mentioned that whereas President-elect Donald Trump’s affect and insurance policies might present a security internet for the inventory market, upside is constrained by excessive focus in a handful of shares, elevated valuations, and stretched positioning by traders.
Hartnett highlighted that the financial institution’s December fund supervisor survey confirmed traders are holding a report obese place in US shares.
The important thing sign for a continued rally, in keeping with Hartnett, is whether or not small-cap shares can rally above a key resistance stage set in 2021.
Small-cap shares briefly broke above the resistance stage following Donald Trump’s election win in November, however they’ve since given up the majority of these beneficial properties and are buying and selling proper across the resistance stage as traders fear about rates of interest staying greater for longer.
Greater rates of interest are significantly painful for small-cap shares as a result of they’re extra delicate to adjustments in borrowing prices. About 40% of corporations within the small-cap Russell 2000 index are profitless, which means debt financing typically performs an integral function in funding their operations.
If the price of debt strikes greater and stays greater when an organization with little to no revenue has debt come due for refinancing, it might finally result in insolvency.
In response to Hartnett, all programs go if small-cap shares can decisively break above their 2021 resistance stage. Nevertheless, if not, it might sign broader market weak spot and he would anticipate asset allocators to trim their obese positioning within the inventory market.
Hartnett recommends traders purchase bonds with Treasury yields doubtlessly peaking close to the 5% stage and rate-sensitive shares typically discovered within the monetary, utilities, and homebuilding sectors.
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