With the recent announcement of aluminum and steel tariffs by the White House, investors in the United States are looking to small-cap stocks as a way to limit their risk without limiting the potential of their growth.
The threat of an escalating trade war internationally between the U.S. and international economies intensifies this behavior. Domestic companies typically stay within their country when doing business. For investors, a U.S.-based company with U.S.-based customers is a reasonably safe refuge to insulate the current standing of their portfolio.
By eliminating global dynamics, investors can remain diversified with small-cap stocks without completely shifting their investment strategies.
Why Are Small-Cap Stocks the Focus of Investors Today?
On March 23, 2018, the markets declined steeply after tariffs, worth billions of dollars, were placed on China by the White House. The three major indexes dropped to their lowest levels since February 8 by the end of the closing day and financial shares dropped to their lowest levels in 6 weeks.
The Dow Jones Industrial Average dropped 2.9%, closing at 23,957.89. The S&P 500 and the Nasdaq Composite both dropped 2.5% and 2.4% respectively. At the same time, the CBOE Volatility Index increased by over 34%.
Yet the day before import tariffs were announced on steel and aluminum, the Russell 2000, which focuses on small-cap stocks, has climbed by 4.1%, while the .SPX, which measures large-cap stocks, rose by just 0.5%.
As of March 27, 2018, at 2:15pm EDT, the Russell 2000 is at 1,523.99, down 0.69% for the day, but up 12.94% over the past 12 months.
Since the 2016 Presidential election in the United States, investors have seen the Trump Administration as being friendly toward domestic companies. Talk of corporate tax cuts, regulatory easing, and a focus on trade deficits generally benefit domestic small-cap companies the most.
Small-Cap Stocks Are Not Without Risk, Even Domestically
In 2017, the Russell 2000 was able to achieve a 13% gain. During the same period, the S&P 500 saw a 19.4% gain. The same level of under-performance continued in 2018 until the first tariff announcements by the White House at the end of February.
Another boost has occurred with the additional Chinese tariffs that were announced in the middle of March. The continued talk of trade wars internationally has also helped small-cap stocks gain back some momentum.
Even with all the positive news, the YTD change for the Russell 2000, as of today, is still -0.16%. That’s still better than the performance of the S&P 500, however, which is -0.81% YTD, shedding more than 3.3% over the past 30 days.
The Dow Jones Industrial Average is seeing even bigger declines. Although over the last 12 months, it has seen a 17.19% increase in performance, in 2018, it has experienced a 1.86% decline. Over the past 30 days, it has lost more than 4.5% of its value.
The Nasdaq Composite Index is the only one that has seen YTD growth in 2018, at 3.25% overall. Although it has experienced a drop of 2.76% in the past 30 days, over the last 12 months, it is up more than 21.3%.
That means small-cap stocks have the potential to limit losses in times of uncertainty. They are not, however, a risk-free investment option. In some instances, tech stocks are over-performing, and small-cap stocks are under-performing.
Do U.S. Investors Need to Worry About Announced Tariffs?
Although the markets have found worry in the talk of metal tariffs and trade wars, only a limited investor demographic should be worried. Those holding a portfolio of steelmakers, automakers, and metal producers would see the greatest impact with the announced tariffs, assuming they are implemented as they’ve been discussed.
Some investors may even be looking at President Trump’s habits of deal-making and assume that the talk of tariffs, or even their initial implementation, is a negotiation strategy and nothing more.
When tariffs are discussed, the issue of inflation can also cause jitters within the market. That is another factor that causes investors to look at U.S.-based small-cap stocks. Domestic production, combined with domestic distribution to local customers, can limit the effects of investors experience should inflation rise.
The markets have encountered some major tests in February and March of this year. Large losses have been offset by new gains, often within the next trading period. Added volatility may create new risks, but it can also create new opportunities.
That’s ultimately why small-cap stocks are attractive during the talk of a trade war and new tariffs. They are already volatile. Adding another layer of volatility provides another layer of protection against potential international declines.