Why U.S. small caps may win out in a trade war
Author: Tony Genua
July 9, 2018
Escalating tensions between the U.S. and a few of its key trading partners including Europe, China and Canada are taking a toll on global equity prices, but some corners of the market are holding up better than others.
U.S. small cap stocks, for example, have outperformed their larger counterparts by a fairly wide margin since U.S. President Donald Trump first announced tariffs on steel and aluminum imports back in early March.
Small cap vs. large cap
In large part, this reflects the fact that most companies in the small cap space derive the majority of their revenue domestically and are therefore better insulated from the potential fallout of a full blown trade war.
U.S. small caps that are more domestically-focused may also benefit more from the White House’s recent tax reform and corporate tax cut. When combined with soaring small business confidence and an overall strong macro backdrop, this could lead to robust earnings growth in the quarters ahead.
A strong mergers & acquisitions (M&A) environment, meanwhile, could be an additional catalyst of small/mid cap performance going forward, particularly for those companies that are disruptive to incumbents and can be acquired at premium valuations.
Last year was the third strongest out of the past 25 in terms of number of M&A deals and with large cap companies receiving a bonanza in cash from tax savings and repatriations, the prognosis of continued strength remains positive.
All added up, the domestically focused nature of U.S. small caps gives them a distinct attribute relative to their large cap and multinational counterparts. And while a broad market sell-off would impact all equities, those that have little foreign revenue exposure should be better protected from the first-order impacts of tariffs.
Tony Genua is a senior vice president and portfolio manager at AGF Investments Inc. He is a regular contributor to AGF Perspectives.