Last week, U.S. equities suffered their gravest losses in more than two years. Fears of an impending trade war between the United States and China crippled markets, with the Dow suffering its worst week weekly loss since January 2016. These losses underscore the challenges faced by large-cap stocks in recent times, a trend that is likely to continue.
In fact, small-cap stocks have posted better performances compared to their larger counterparts over most of this month. Investors have sought out smaller companies for two reasons. First, they are likely to remain relatively insulated from the impact of a trade war. Second, they are expected to benefit appreciably from recent tax cuts. This is why it makes sense to invest in select small cap stocks at this point.
Small Caps Outperform Larger Counterparts
Since the end of February, the Dow and the S&P 500 have lost around 6% and 4.6%, respectively. In contrast, the small cap heavy Russell 2000 index has edged 0.2% down. This indicates that investors are keen to snap up small caps for their tax cuts and trade war-related advantages.
Such a tendency has also gained favor among the investing community because large manufacturers are bound to experience a profits squeeze as Trump’s steel and aluminum tariffs raise input costs. Further, retaliation from China and the European Commission could weigh on the bottom lines of large companies with multinational operations.
In such an event, small-cap stocks look to be relatively better investments. This is because most of them are domestically focused with negligible foreign exposure. This enables them to gain from recent tax reductions while protecting them from the fallout of a potential trade war.
A replay of Post-Election Surge and Fall Likely?
One section of investors feels that the current scenario is nearly identical to the situation prevailing immediately after Trump’s victory in November 2016. At that time, small-cap shares had experienced a tremendous upsurge, buoyed by speculation surrounding tax cuts and protectionist measures.
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