Immediately after Trump won the election the S&P 600 SmallCap Index blasted 6% higher, breaking through overhead resistance and hitting a new all-time high.
The index gave up some of its gains last week – we’ll get to why this happened in a minute – but the initial move was extremely notable because it signaled a major change in the trading pattern for small caps.
Let’s explore why stocks of smaller companies jumped so much, so quickly, and what lies ahead.
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Small Caps Break Out to All-Time Highs
First, a couple of charts.
This is what the S&P 600 looks like on a daily chart going back about a year ...
And this is what it looks like going back four years, showing the index’s all-time high of 1,477 from November 2021 ...
Suffice it to say, an index that hasn’t gone “anywhere” in three years that blasts out to all-time highs is a notable event.
Why Such a Big Upside Move?
So why is this happening?
Let’s forget for a moment about any concerns whatsoever, put on our raging bull market hats, and consider the positives for the market and for small caps.
First, the election is over and we have a clear winner. That removed the overhang of uncertainty going into the event and sparked a relief rally.
Second, the Trump administration will almost certainly be pro-business, pro-U.S., and work to cut regulations and taxes. The corporate tax rate could go from 21% to 15%. These initiatives should be very friendly for stocks, including small caps.
Third, the appointment of Elon Musk to slow/slash government spending might actually work. Love him or hate him, it’s hard to argue that Musk hasn’t accomplished what many think was impossible, several times. If successful, concerns about a U.S. government debt crisis could prove to be overblown. That could be a positive for the market.
Fourth, the market reacts favorably to rising revenue and earnings expectations, which are going up for 2025 on expectations of Trump’s business-friendly agenda.
Finally, the Fed just cut rates, again. And Powell did not sound overly hawkish during his press conference.
Why Did Small Caps Retreat Last Week?
Of course, there are plenty of risks out there too. And the market began to focus more on emerging risks last week, pushing the stock market down, especially later in the week.
What’s up?
First and foremost, Jerome Powell has begun to dial back on rate cut talk.
There has been some debate about whether the Fed should be cutting at all given how strong the economy and labor market is. While Powell sounded relatively dovish during his FOMC meeting press conference on November 7, he sounded more hawkish last Friday, saying, “... the economy is not sending any signals that we need to be in a hurry to lower rates.”
It’s not a coincidence that stocks sold off on Friday as expectations for a December rate cut fell to 60%.
Second, yields have continued to rise. The 10-year yield sat at 4.45% at the end of last week. While the relationship between yields and the stock market gets fairly nuanced, the bottom line right now is that yields have shot up to levels where the market is getting a little uncomfortable.
Third, there is some uncertainty out there around potential impacts to certain areas of the market due to Trump’s agenda. The best example is Big Tech, which could be in the crosshairs of Trump’s pick of Brendan Carr for chairman of the FCC.
Lastly, following the election, investors got bullish very quickly. The Bull/Bear ratio shot up to 2.9, and a lot of “junk” stocks rallied, with some ascending to completely unreasonable levels. While a Bull/Bear ratio north of 3.0 can certainly be sustained during a market rally when the fundamentals support it, it’s not entirely surprising that we’ve seen some turbulence following such a significant post-election relief rally.
What’s Next for Small-Cap Stocks?
It’s been a wild ride since the election. And there are a lot of moving pieces under the hood that will cause certain small-cap sectors, let alone individual stocks, to do better/worse than others as we move forward.
But big picture, I think the future for small caps looks quite bright in an environment where there’s a renewed focus on U.S. companies, fewer regulations and lower taxes.
The S&P 600’s breakout to all-time highs is something I’ve been waiting for, and now that it’s happened the odds of the index rising further have increased.
Whether you agree with Trump’s agenda or not, the bottom line is that stocks tend to react well to expectations of higher revenue, profits and profit margins. And that’s the setup we’re looking at.
For broad-based small-cap exposure, I’m a big fan of high-quality ETFs, like the iShares S&P 600 Core ETF (IJR) and the Vanguard Small Cap Growth Index ETF (VBK), which offers a little more exposure to the growth end of the small-cap spectrum.
For those wanting to buy individual small-cap stocks the best thing to do is grab a subscription to my Cabot Small-Cap Confidential advisory, in which I cover the best small-cap stocks I can find in the market. You can learn more, and grab a trial subscription, by clicking here today.
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