- Market action shows that size matters right now…
- Trump’s latest efforts to trigger small-cap rally.
- What if the tax cuts aren’t passed?
When it comes to the stock market action of the last 12 months, size matters.
As you know, fueled by post-election enthusiasm, stocks of all sizes rose in the U.S. as investors bet big on economic growth.
But small caps led the pack, by far.
In the two-week period following the election, the small-cap benchmark Russell 2000 index rose as much as 15% — more than twice the gain of the large-cap S&P 500 over the same period.
However, over the last six months, a quiet divergence has emerged in the stock market…
Small caps have dropped 2% while the market’s biggest stocks have gained 4%.
But as senior analyst Jonathan Rodriguez argues below, it’s time to load up on small caps in a big way…
Ahead of the tape,
Chief Investment Strategist, Wall Street Daily
A Turning Tide
So far, President Trump has struggled mightily to get the ball rolling on his legislative agenda.
To be sure, the president has signed more than 40 bills into law — and issued as many executive orders.
The big-ticket stuff he ran his campaign on, however, has yet to come.
I’m talking about defense, infrastructure and tax reform.
And the all-but-certain death of TrumpCare has spooked the financial markets into believing that all his other proposed bills will fail, too.
But it’s far too early to make that call.
As I noted in yesterday’s column, tax reform, the next piece of Trump’s legislative package, is about to be taken up by Congress.
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And after a bruising battle on health care ending in an ugly, public defeat, Republicans will be far more likely to work with Democrats to get the win here.
Here’s how a tax-reform victory sets up small caps for a major rally…
The Truth About Taxes
As you may know, small American companies rely heavily on domestic sales while most large companies generate a fair amount of their revenue overseas.
This has a huge effect on their tax burdens.
According to Lori Calvasina, small- and midcap U.S. equity strategist at Credit Suisse, the effective tax rate for the Russell 2000 is 32% while the S&P 500 rate stands at 26%.
If the tax rate comes down to 15%, small caps could see a whopping 50% increase in post-tax profit. That’s against a 42% increase for large caps.
At 29.6 times forward earnings, small caps aren’t cheap on a bottom-line basis compared with large caps (18.7).
But the Russell 2000 trades at just 1.1 times forward sales — a 45% discount to the S&P 500 (2.0 times).
And small caps trade at 1.9 times forward book value — 37% lower than their large-cap peers.
Of course, there is a chance that the tax cuts don’t pass.
But because the market is overestimating failure and selling off small caps broadly, these issues can be scooped up at a steal.
According to data from Credit Suisse, the sectors that pay the most in taxes are the telecommunications, utilities and consumer discretionary.
If you’re after the biggest small-cap pop on tax reform, these are the names you want to buy now.
On the hunt,
Senior Analyst, Wall Street Daily