Stay in Small Caps Even If Trade Woes Ease: Stifel

While the easing of trade tensions may lure investors back to global large caps, a handful of analysts on the Street says there's more room to run for U.S. small-cap equities.

The Russell 2000, the benchmark index for small-cap stocks, is up 12.6% this year through Monday close, compared to the S&P 500's 8.4% return over the same period. While the group has typically been viewed as riskier than the broader U.S. stock market to due its higher volatility, recent trade wars have helped reel in funds and lead to its outperformance versus the mega caps. Roughly 80% of small-cap revenues are domestic, therefore are less impacted by tariffs and other trade retaliations. (See also: Intl. Stocks Will Outperform Domestic Market: JPM.)

In a note to clients Friday, Stifel analysts forecast the outperformance of smaller firms to continue into year's end as they continue to benefit from the GOP tax overhaul and post strong financial performance. 

Increased Investment Spending Seen

"As we move into the second half of the year, the market environment is positioned well for U.S. small cap equities to remain one of the preferred markets," wrote Stifel's global head of investment strategy, Michael O'Keeffe. "Small business owners continue to anticipate greater sales and even better business conditions for the remainder of the year. We expect this to result in increased investment spending that ultimately leads to GDP growth."

O'Keeffe highlighted the strength in second-quarter results for small caps, which saw earnings increase an average of 34.8% and sales jump 10.5%. He also noted that small caps are more insulated from geopolitical developments and trade tensions. "Shark Tank" star and angel investor Kevin O'Leary echoed this sentiment in an interview with CNBC's "Trading Nation" on Monday, indicating that even if trade tensions persist, small caps are still a great bet. 

"I say there is 20% more cash to come to these companies in the next 24 months through tax reform, so I am staying on this trade. I am betting they continue to outperform not only the S&P [500], but maybe even emerging markets. There is tremendous value to be unlocked in small caps in America," said O'Leary. 

The high-profile investor expects the full impact of the tax reform, and specifically deregulation, to play out in enhanced cash flows for small caps over the next two years. (See also: 3 Major Recession Signs to Watch For: Mark Tepper.)

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