A worryingly large number of US stocks are expensive, crowded, and pose a downside risk to the S&P 500, says Bank of America

• Mega-cap growth stocks are overcrowded, expensive, and dampen the outlook for the S&P 500 in 2021, BofA said.
• A team of strategists said in a Friday note that bullish sentiment and high valuations indicate risk in the stock market.
• With the S&P 500 set for flat returns this year, BofA favors value stocks, small-caps, and cyclicals.
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Mega-cap growth stocks are vulnerable to a downturn that could weigh on the whole S&P 500 index, according to Bank of America.

A team of strategists led by Savita Subramanian said in a Friday note that large-capitalization growth stocks - assets which make up a large chunk of the US market - are expensive and crowded, even when accounting for historically low interest rates.

Stocks are forward-looking instruments, and investors attribute the record rally in stocks during the COVID-19 pandemic to the fact that equities were anticipating future growth. However, Bank of America said that some stocks, particularly those within large-cap growth "overshot," future growth estimates.

Now, "bullish sentiment, lofty valuations, massive dispersion between rich and cheap stocks, and no rewards for EPS beats all indicate risk," the strategists said.

All of this has led Bank of America to a 2021 year-end price target of 3,800 for the S&P 500, a slight decline from current levels.

This doesn't imply that 2021 won't be a positive year for the economy, however. With the vaccine rollout underway, a large fiscal stimulus about to be passed, and impressive earnings beats, BofA economists are forecasting 6.5% US GDP growth this year.

The strategists emphasized that the S&P 500 isn't a pure reflection of the economy-it's more global, more levered to capex than consumption, has operating leverage, and has more exposure to technology, media, and telecommunications than the broader economy. Therefore, while the S&P 500 will remain flat for this year, profits and economic growth will be strong.

Against this backdrop, the strategists reiterated their recommendation for cyclical and small-cap stocks. They also said value stocks look attractive.

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