The Bottom Line
- U.S. small cap stocks rose sharply in the aftermath of the US election, with the Russell 2000 hitting a new record high on March 1st.
- By that measure, small-caps have soared in price by 15.8% between Election Day and March 6—notably better than large-caps, which were up 11% over the same period as represented by the S&P 500.1
- Why the disparity? To some degree, it’s the perception that small companies would benefit more than large ones from the tax reform, deregulation and more infrastructure spending expected from Trump’s administration.
- Small businesses appear to echo that sentiment: the NFIB’s January survey of small business optimism reached its highest level since 2004 after surging 7.4 points (the biggest hike on record) the month before.
- Why would smaller companies benefit more from new policies in Washington? Consider corporate tax cuts. Small firms reportedly tend to pay a higher effective rate than larger ones, so they could have more to gain.
- More broadly, the new administration’s domestic focus—incentivizing domestic production and jobs growth—could brighten prospects for smaller companies, which tend to do much less business overseas.
- Changes that encourage repatriation of overseas profits could also help create a more favorable environment for mergers and acquisitions (M&A)—helping push up prices for smaller companies that are M&A targets.
- Whether or not all of this plays out remains to be seen, but the small-cap market has certainly priced in a lot of promising future results.
- And with valuations higher, diversification and stock selection become more important—something that active small-cap managers may be better positioned to offer investors than passive solutions.
- Indeed, active management is well suited for the small-cap sector where pricing inefficiencies can be greater due to less information—that plays into the strengths of an investment process focused on identifying gaps between expectations embedded in current pricing and the long-term intrinsic value of underlying businesses.
1 Source for all data is Bloomberg.