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The post-election rally in US small capitalisation stocks – modestly sized listed companies that form the bedrock of Corporate America – is over, Bank of America’s strategists have declared.
The Russell 2000 small caps index reached a new all time record on Wednesday, and is up 19 per cent since the November presidential election, as investors piled into what many analysts reckoned would be the biggest winners from Donald Trump’s economic plans.
But with prices now at “tech bubble” levels – at the 98th percentile of historical valuations since 1979 – Bank of America Merrill Lynch is scrapping its long-standing buy recommendation.
Despite the rough start to the year, we have maintained our tactically bullish stance on US small cap equities on the idea that small caps are the best-positioned to benefit from increasing optimism around stimulus and tax reform…. (But) In our view, this last bout of optimism is likely to signal the end of the Trump Put, as friction arises over the funding the bill.
In addition to eye-watering valuations and the fading chances of a tax overhaul, BAML’s strategists also highlighted exceptionally low corporate borrowing costs and expected volatility – which would disproportionately harm small caps if reversed – and the possibility that economic data will begin to turn choppier. They said:
With positive economic surprises coming off of five-year highs, the math alone makes it difficult for data to accelerate from here.