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Small-cap stocks have been on fire since the election, with the Russell 2000 (^RUT) handily beating its large-cap cousin, the S&P 500 (^GSPC).
And while small-cap investors have been burned by a series of ill-fated rallies in this “weird” bull market, big changes are underway for reasons that are both backward- and forward-looking.
Steve Sosnick, chief strategist at Interactive Brokers, pointed to surging US interest rates as a big driver of small caps’ chronic underperformance over the past two years, which is unlike most of the bull markets this century.
“Small caps don’t like higher rates because many of [them are] money-losing stocks, which means they have to be able to borrow money to stay afloat,” he said on a recent episode of Yahoo Finance’s Stocks in Translation (see video above or listen below). “They prefer lower rates.”
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But history might be about to work in favor of small caps when it comes to seasonality — the annual, semi-predictable vicissitudes of the market.
“Seasonally speaking, small caps are set up for their annual year-end rally into [the first quarter],” Jeff Hirsch, editor in chief of the Stock Trader’s Almanac, wrote.
Five decades ago, his father, Yale Hirsch, first noticed small caps had a tendency to lead from mid-December to mid-March. He named this phenomenon the “January effect” for the month that tends to see the greatest outperformance and gains.
“In a typical year the smaller fry stay on the sidelines while the big boys are on the field,” Jeff Hirsch wrote. “Then, around early November, small stocks begin to wake up, and in mid-December, they take off.”
Investors are also weighing ideas from the incoming Trump administration that will shape the fortunes of small caps.
Tariffs and a tougher immigration policy could raise the cost of goods (and services, in some cases). And if companies cannot pass these higher costs on to consumers, margins and profitability will be pressured, squeezing small-cap companies that are already walking a tightrope.
Meanwhile, the potential for deregulation and Cabinet-level leadership changes likely work in favor of smaller companies. “Whoever would replace [Lina Khan at the Federal Trade Commission] would likely be more lax about [mergers],” Sosnick said, adding, “Small-cap stocks are more likely to be taken over.”
Trump’s “America First” approach could also help domestic businesses, which includes most small companies. “Protectionism probably helps these companies more than most,” Sosnick said.
