Bank of America Hartnett: "Mid-cap stocks" have the highest win rate before the midterm elections; the appeal of tech giants is diminishing

According to the latest report released by Bank of America strategist Michael Hartnett and his team, as the appeal of tech giants wanes, U.S. small- and mid-cap stocks have become the best investment targets ahead of the midterm elections.

The team recommends investors adopt a “long Main Street, short Wall Street” strategy until the Trump administration shifts policies to address affordability issues and boost approval ratings. Hartnett points out that Trump’s “radical interventions” to lower energy, healthcare, credit, housing, and electricity prices are putting pressure on sectors such as energy giants, pharmaceutical companies, banks, and large tech firms, and this environment will make smaller stocks the primary beneficiaries.

The report specifically highlights the structural challenges facing tech giants, noting that these companies are undergoing a shift from light-asset to heavy-asset business models. According to Bank of America estimates, large tech stocks have spent about $670 billion on AI-related capital expenditures this year, accounting for 96% of their cash flow, far above the 40% in 2023. Strategists openly state that these tech giants “no longer have the best balance sheets or the largest share repurchase programs.”

Meanwhile, Bank of America’s “Bull-Bear Indicator” rose to 9.6 this week, reaching the highest level since March 2006, signaling that the market has entered an “extremely bullish” zone and triggering a sell signal. Hartnett believes that this marks the market’s “positioning peak, liquidity peak, and inequality peak,” and the current market correction is overdue and healthy.

“Long Main Street, Short Wall Street”

Hartnett’s team clearly outlines a specific trading approach: short targets they refer to as “billionaire brother concept stocks,” including Tesla, Palantir, and Nvidia; while going long on themes representing “Main Street,” such as small caps, real estate investment trusts (REITs), and banks. Hartnett plans to maintain this stance until President Trump’s approval ratings improve and he successfully adjusts policies to address housing affordability.

The logic behind this strategy is that investors are concerned about potential disruptions caused by artificial intelligence and are beginning to rotate funds into sectors that could benefit from policies aimed at reducing living costs. Market data already shows signs of this rotation, with the Nasdaq 100 experiencing its largest three-day decline since April this week, down 4.6%. Additionally, since the beginning of this year, the S&P 500’s performance has lagged its equal-weighted index by 4.2 percentage points.

Strategists note that, in the context of the Trump administration’s efforts to lower living costs, broad categories of companies sensitive to improved growth prospects are performing well, which suggests that small- and mid-cap stocks could benefit from a “prosperity” before the midterm elections.

Tech Stocks Face “Cash Flow” Test

The report issues a stern warning regarding the so-called “Seven Giants” market leaders, considering their shift toward heavy-asset business models a “significant threat.”

Supporting data underpin this view: large tech companies are allocating 96% of their cash flow to AI capital expenditures. This high level of capital spending means they no longer have advantages in balance sheet quality or share repurchase capacity. Wall Street is wisely shifting from AI expenditure spenders to beneficiaries, moving from service sectors to manufacturing.

Hartnett expects that, although market speculation bubbles are receding, key support levels for major asset prices should hold, such as the XLK tech ETF at $133 and gold at $4,550. However, he also warns that Asian tech stocks exhibiting bubble-like recent performance may experience another volatile extreme position unwind.

Sentiment Indicators and Global Asset Rotation

Bank of America’s “Bull-Bear Indicator” aims to quantify investor fear and greed. It issued a “sell” signal on December 17, and the current reading further confirms extreme market sentiment.

On a macro asset allocation level, Hartnett observes a shift from “American exceptionalism” toward “global rebalancing.” His preference for international stocks since late 2024 has proven to be prescient. The report notes that the current adjustment has wiped out $2 trillion in cryptocurrency market capitalization, equivalent to 10% of U.S. consumer spending.

Looking ahead to 2026, Hartnett believes the best investment opportunities lie in international stocks, Chinese consumer concept stocks, and emerging market commodity producers. Since the beginning of this year, emerging market stocks have risen 7%, while global markets outside the U.S. have increased by 5%. He cites historical events such as the end of the Bretton Woods system in 1971, the 2008 global financial crisis, and the 2020 pandemic, pointing out that major geopolitical events often signal significant shifts in asset market leadership.

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