Small cap stocks have been leading the stock market surge since Donald Trump’s surprise election as U.S. president. The Russell 2000 Index, a widely followed measure of small cap performance, opened the week's trading more than 10% above its election day close, according to the Wall Street Journal. The index has risen for eleven straight trading days, its longest winning streak since June 2003.

Meanwhile, the large cap S&P 500 Index and Dow Jones Industrial Average (DJIA) have advanced, respectively, 2% and 3% over the same period. Investors are betting that the effects of Trump’s policy initiatives will be especially beneficial for fast-growing small caps. (See: America’s Startups Crisis:It’s Hurting the Economy.)

As of the end of October, the average Russell 2000 company had a market capitalization of about $1.8 billion, compared to $40 billion for S&P 500 members.

Small Cap Winners

Trump’s commitment to infrastructure spending has propelled shares of construction firms. Shares of Tutor Perini Corp. (TPC) are up by 32% since the election. Before then, losses on the big Hudson Yards project in Manhattan had weighed on the company. Scorpio Bulkers Inc. (SALT) is a shipping company that moves construction materials. It’s up 50%. Trump's silence on the drug price controversy has been taken as good news for pharmaceutical and biotech firms. Shares of PTC Therapeutics Inc. (PTCT) have rocketed up by 141%. (See: Drug Stocks Rebound After Clinton Defeat.)

Trump and the Small Caps

Analysts see outsize benefits for small companies in Trump’s expected initiatives, according to the Wall Street Journal. Protectionist trade policies would push up the prices of imports, reducing competition for domestic firms. Meanwhile, small U.S. firms that export little, if anything, would be less affected by retaliatory trade barriers. Fluctuations in the value of the U.S. dollar spurred by Trump’s policies also would be irrelevant for small companies that do not export. (See: Trump Allies Attack $4.5 Trillion Fed Balance Sheet.)

Analysts also note that small companies tend to pay higher proportions of their revenue in taxes than do big corporations, and the costs of regulatory compliance also are greater relative to income. In particular, as noted in Barron’s, Trump’s proposal to reduce the corporate tax rate to 15% would be a big win for small companies that often end up paying the 35% federal rate. Many multinationals already can avail themselves of tax strategies that push their effective rates down to the teens.

Low Relative Valuations

As quoted in Barron’s, Jim Paulsen, chief investment strategist of Wells Capital Management, sees benefits for small caps in higher inflation under Trump. Big corporations normally have greater leeway to protect profit margins by cutting costs when prices fall. In eras when interest rates rise (usually as the result of higher inflation), an opposite dynamic takes effect and small caps tend to outperform large caps.

Another force is fueling the small caps. Credit Suisse strategist Lori Calvasina tells Barron’s that the case for small caps right now is bolstered by their low average valuation relative to big companies, along metrics such as price/earnings, price/book and price/sales ratios.

 

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