President-elect Donald Trump may seem like the face of big business, but he has already been good for US small companies.
Since the announcement of his US presidential election victory on 9 November, the Russell 2000 index of US small cap companies has risen by more than 13%. By contrast, the S&P 500 index of large cap US companies rose by less than 6% in the same period (see chart 1, below).
This contrasts with the relative performance of the two indices in the three years since December 2013 (see chart 2, below). For most of this period, large cap ‘bond proxies’ rose in value as investors sought yield in a low interest world.
Keep it local
Frank Talbot, head of US investment research at Citywire, said this small cap resurgence had been driven by Trump’s protectionist stance and infrastructure spending plans. ‘His focus is on US companies making US things, bought by US consumers. This plays into the hands of the
masses of smaller US companies,’ he said.
Around 40% of S&P 500 revenues come from outside the US, while the figure is less than 20% for the Russell 2000. As such, small US companies are better positioned to benefit from Trump’s more inward-looking approach.
US small caps were strengthening even before the US election. ‘Despite Trump’s campaign rhetoric, the strength of the US economy is good. There is low unemployment, a recovering housing sector and a recovering US consumer. Small caps were benefiting from this before the Trump vote,’ Talbot said.
‘Small caps have more sensitivity to the US economy and have a higher median tax rate,’ said San Jose. ‘This should allow them to benefit from any potential lowering of corporate tax rates. Better economic growth should also support further small cap outperformance, particularly if the US dollar continues to strengthen.’
Stephanie Sutton, investment director at Artemis Investment Management, agreed that infrastructure spending and corporate tax reform would boost small firms. She said small companies pay less tax abroad than more global large caps, so would benefit from US corporate tax rate reductions.
Sutton believes increased US defence spending will feed through to this sector. ‘Mercury Systems, for example, makes components for missile guidance, while Leidos provides information technology workers for the defence industry,’ she said. ‘We think these two companies will benefit from a rise in defence budgets.’
Bank on it
Sutton is positive on financials and expects the US regional banks, ‘which are relatively small but not microcap’, to benefit from corporate and individual tax cuts and deregulation of the banking sector. The steeper yield curve since the election should boost margins as banks can borrow at a lower rate than at which they lend.
San Jose is positive on US equities as a whole. ‘The key reasons for our positive view on the asset class are that profits remain healthy and could improve as headwinds from the strong US dollar and low energy prices moderate,’ he said. ‘What’s more, the US consumer is in decent shape and comparative values between equities and bonds remain favourable for equities as an asset class.’
Those who expect this US small cap trend to continue can gain passive exposure through the Russell 2000 exchange-traded fund. However, active outperformance in US small caps is better than with US large caps.
Talbot points out that active fund managers can avoid areas such as technology that may be negatively hit by the Trump effect. ‘Around 15% of US small caps are in technology,’ he said. ‘Tech is internationally focused, so these companies depend on a conducive global trading environment, which may not be forthcoming in a Trump presidency.’