U.S. Small-Cap Stocks Underperforming Large Cap Stocks
U.S. small-cap stocks (market cap between $200.0 million and $2.0 billion) got a big boost back in November after Donald Trump won the U.S. election. Since the start of December though, small-cap stocks have been trading sideways and are underperforming the broader S&P 500. With Donald Trump’s proposed tax cuts on hold, the small-cap rally is starting to unravel.
Small-cap stocks were the biggest winners after Donald Trump’s surprise election win. Between Election Day (November 9, 2016) and the end of the year, the Russell 2000, the benchmark small-cap index, advanced 13.6%. By comparison, the S&P 500 increased just five percent.
Investors were encouraged that Donald Trump’s pledge to tax cuts, increase infrastructure spending, and slash red tape would boost corporate earnings. All of which would be a big boon to small-cap stocks.
President Trump’s America First platform would also benefit small-cap stocks because small-cap stocks get most of their revenue domestically. President Trump pledged to boost U.S. gross domestic product (GDP), which was an anemic 1.6% in 2016 to four percent during his presidency.
Russell 2000 stocks generate less than 20% of revenues outside the U.S. while S&P 500 companies generate roughly half of their revenues from abroad. As a result, investors were optimistic that Trump’s pro-business strategies would juice the U.S. economy and position small-cap stocks for strong growth.
But that optimism has been tempered. Back in March, the Trump administration withdrew its healthcare bill. On the campaign trail, Trump said Obamacare was a failure and, if elected, he would give Americans a much better alternative. Many Republicans believed the passing of the American Health Care Act (AHCA) would be a shoe-in. It wasn’t; it’s been shelved.
This failure to get the healthcare bill passed raises concerns about whether Trump will be able to fulfil his other campaign promises passed. The president’s proposed tax cuts and increased spending are a big part of how he plans to get annual U.S. GDP to four percent.
Russell 2000 Turning Bearish
Failing to get these plans into motion will put additional stress on an already fragile U.S. economy. That, in turn, will undermine already stressed small-cap revenue and earnings potential. This could also put the entire bull market in jeopardy.
Fast-forward to April and Trump’s tax cuts are not even on the horizon. The White House recently said it may not pass its huge tax plan before Congress goes into recess in August.1
And judging by the stock market, investors are not so sure Trump will be able to deliver on his proposed tax cuts anytime soon. In fact, the post-election Trump rally is stalling.
The Russell 2000, S&P 500, Dow Jones Industrial Average, NYSE, and NASDAQ are all trading below their 50-day moving averages. This is a bearish sign. The Russell 2000 is actually in the red year to date, and a number of key small-cap exchange traded funds (ETFs) have also turned bearish.
The iShares Russell 2000 ETF (NYSEArca/IWM) has been down 1.3% since the start of January. Meanwhile the iShares Russell 2000 Growth ETF (NYSEArca/IWO) and the Vanguard Small-Cap Growth ETF (NYSEArca/VBK) are both below their 50-day moving averages.
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- “White House Walks Back Timing, Size of Tax Cuts; Puts Stock Rally in Jeopardy,” Yahoo! Finance, April 11, 2017; http://finance.yahoo.com/news/tax-reform-delay-likely-ding-230800347.html.
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