PART ONE/ Small caps have surged since Election Day. As shown in Figure 1, the small cap Russell 2000 Index has outperformed the large cap S&P 500 by 8.1% since November 8, 2016. The relative strength has been driven by several election-related factors, including prospects for corporate tax reform, deregulation, and President-elect Donald Trump’s efforts to encourage U.S. manufacturing and discourage offshoring. Here we share our thoughts on the potential policy impact on small caps and discuss whether recent small cap strength is sustainable.
Small cap stocks may be subject to a higher degree of risk than more established companies’ securities. The illiquidity of the small cap market may adversely affect the value of these investments. The Russell 2000 Index measures the performance of the small cap segment of the U.S. equity universe. The Russell 2000 Index is a subset of the Russell 3000 Index representing approximately 10% of the total market capitalization of that index.
Election-Driven Rally
Small caps have benefited from the election results in several ways. First, smaller companies pay higher corporate tax rates than their larger cap counterparts that benefit more from lower overseas rates. The median corporate tax rate for the companies in the Russell 2000 is 33%, compared with 29% for the large cap S&P 500. That means smaller market cap companies have more to gain from a reduction in the U.S. rate, believed to arrive later this year.
Smaller cap companies also have more to gain from the Trump administration’s efforts to bring more offshore manufacturing back to the U.S. Although some low value manufacturing won’t ever be brought back, proposals from Trump and congressional Republicans have suggested more favorable tax treatment for companies with U.S. production. The president-elect’s social media campaign to discourage offshoring is likely to continue and generally hurt larger companies, potentially to the benefit of smaller U.S.-focused suppliers.
Small cap stocks may also benefit from a more favorable environment for mergers and acquisitions (M&A) under Trump. Deal activity slipped in 2016, with 10% fewer acquisitions announced compared with 2015, according to FactSet data. We would not be surprised to see M&A pick up in 2017 due to a more favorable regulatory climate for deal approvals, a clearer policy roadmap, and the hundreds of billions of dollars likely to be repatriated back to the U.S. because of a lowered tax rate, a highly probable piece of the Trump/Republican tax plan.
We should point out that repatriation of overseas cash benefits larger multi-nationals more than smaller cap companies with less overseas revenue and less cash trapped overseas for tax reasons. We expect a sizable portion of the more than $2 trillion in overseas cash to be used for acquisitions, in addition to share repurchases and capital expenditures.
Small business owners have responded to these proposals, and the potential for deregulation, pushing the National Federation of Independent Business (NFIB) Small Business Optimism Index up a record 7.4 points in December to a 12-year high and the strongest year-over-year gain (10.6 points), since October 1983.
Small cap stocks may be subject to a higher degree of risk than more established companies’ securities. The illiquidity of the small cap market may adversely affect the value of these investments. The Russell 2000 Index measures the performance of the small cap segment of the U.S. equity universe. The Russell 2000 Index is a subset of the Russell 3000 Index representing approximately 10% of the total market capitalization of that index.
Election-Driven Rally
Small caps have benefited from the election results in several ways. First, smaller companies pay higher corporate tax rates than their larger cap counterparts that benefit more from lower overseas rates. The median corporate tax rate for the companies in the Russell 2000 is 33%, compared with 29% for the large cap S&P 500. That means smaller market cap companies have more to gain from a reduction in the U.S. rate, believed to arrive later this year.
Smaller cap companies also have more to gain from the Trump administration’s efforts to bring more offshore manufacturing back to the U.S. Although some low value manufacturing won’t ever be brought back, proposals from Trump and congressional Republicans have suggested more favorable tax treatment for companies with U.S. production. The president-elect’s social media campaign to discourage offshoring is likely to continue and generally hurt larger companies, potentially to the benefit of smaller U.S.-focused suppliers.
Small cap stocks may also benefit from a more favorable environment for mergers and acquisitions (M&A) under Trump. Deal activity slipped in 2016, with 10% fewer acquisitions announced compared with 2015, according to FactSet data. We would not be surprised to see M&A pick up in 2017 due to a more favorable regulatory climate for deal approvals, a clearer policy roadmap, and the hundreds of billions of dollars likely to be repatriated back to the U.S. because of a lowered tax rate, a highly probable piece of the Trump/Republican tax plan.
We should point out that repatriation of overseas cash benefits larger multi-nationals more than smaller cap companies with less overseas revenue and less cash trapped overseas for tax reasons. We expect a sizable portion of the more than $2 trillion in overseas cash to be used for acquisitions, in addition to share repurchases and capital expenditures.
Small business owners have responded to these proposals, and the potential for deregulation, pushing the National Federation of Independent Business (NFIB) Small Business Optimism Index up a record 7.4 points in December to a 12-year high and the strongest year-over-year gain (10.6 points), since October 1983.
