As concerns over trade wars escalate, investors may find refuge in small-cap stocks, which have been handily beating the broader market this year. That outperformance should not be hindered by the deterioration of trade relations and the consequent volatility in the U.S. dollar, as small caps have a much lower sensitivity to trade risks. Lower exposure to trade risk along with beneficial tax policy exposures, relative strength in U.S. economic growth, and potential merger activity, make small caps like GrubHub Inc. (GRUB), Exact Sciences Corp. (EXAS) and Aspen Technology Inc. (AZPN), especially attractive in the current environment, according to CNBC.

 Stock  Performance YTD
 GrubHub  58.1%
 Aspen Technology  44.8%
 Exact Sciences  32.0%
 S&P 500  3.5%

Small Caps vs. Big Caps

The outperformance of small caps has largely been due to the effects of tax cuts and regulatory reform, with smaller companies receiving double the amount of tax-cut benefits than were received by large companies during the first quarter. Looking ahead, the full effects of the tax cuts have yet to be completely reflected in small-cap stock prices. As domestic-oriented companies are likely to receive a greater share of the extra consumer spending dollars from individual tax cuts than global-oriented companies, expect outperformance to continue.

The still-growing U.S. economy in the midst of forecasts of weaker growth and tighter financial conditions in Europe and emerging markets will also provide more exclusive benefits to small domestic-oriented companies, according to CNBC. (To read more, see: US Stocks May Stage Rebound Amid Warnings Signs.)

Small caps, as potential takeover targets, could also get a boost from increased M&A activity. The repatriation of cash by large multinational companies following the tax cuts is expected to be used, at least in part, for such deals. Adding the reduced concern over regulations that might have prevented such deals, the rising of a large M&A wave is a strong possibility.

GrubHub, an online food ordering service, beat expectations in this year’s first quarter on a 72% increase in the number of its diners and several key acquisitions, including Yelp Inc.’s food delivery platform Eat24, Foodler Inc. and OrderUp. Aspen Technology has been riding higher on a number of earnings surprises over the past year, with as much as an 82.5% surprise around this time last year.

Small Caps Leading the Charge

The Russell 2000 index, which tracks the performance of approximately 2,000 small-cap stocks, is far outpacing the S&P 500’s 3.5% rise with a more than 11% gain on the year, and it continues to reach new highs that fuel optimism of a continuing bull market.

“You’ll never see a bear market start with the Russell 2000 hitting an all-time high,” Peter Costa, a governor at the New York Stock Exchange, told CNBC around the middle of last month. (To read more, see: Small Caps in Russell 2000 Break Out to Fresh Highs.)

B. Riley FBR’s Art Hogan made a prediction around the same time Costa gave his remarks that he sees the Russell 2000 rising another 5.4% to hit 1,800 by the end of the year, saying, “This is a trade that’s got legs.”

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