BofA says Trump will support stocks this year, but will keep a close eye on one key area of ​​the market

• Bank of America sees small-cap stocks as a key indicator to watch for the broader stock market.

• High concentration in a few stocks and elevated valuations are limiting equity market growth, BofA said.

• Small-cap stocks face the challenges of high interest rates, which affects unprofitable companies.

Bank of America said in a note on Friday that one key area of ​​the stock market will help determine whether the bull run continues.

Michael Hartnett, investment strategist at the bank, said that while President-elect Donald Trump’s influence and policies may provide a safety net for the stock market, growth is limited by high concentration in a few stocks, elevated valuations and tight investor positioning.

Hartnett pointed out that a December survey of the bank’s fund managers showed investors holding a record position in US stocks.

A key signal for continued recovery, according to Hartnett, is whether small-cap stocks can recover above the key resistance level set in 2021.

Small-cap stocks briefly broke above resistance after Donald Trump’s election victory in November, but have since lost most of those gains and are trading right around resistance as investors worry interest rates stay longer longer.

Higher interest rates are especially painful for small-cap stocks because they are more sensitive to changes in borrowing costs. About 40% of the companies in the Russell 2000 index are small caps are free, meaning that debt financing often plays an integral 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, it’s all systems go if small-cap stocks can decisively break above their resistance levels in 2021. However, if not, it could signal broader market weakness and he would expect asset allocators to reduce their excessive positioning in the stock market.

Hartnett recommends investors buy bonds with Treasury yields that could potentially peak near the 5% level and rate-sensitive stocks often found in the financials, utilities and construction sectors.

Read the original article at Business Insider