With a Contested Election, Small-Caps Can Be a Safe Hiding Place

Some market observers believe that a protracted contested election could favor smaller stocks.

That scenario could spark opportunity with exchange traded funds, including the Principal U.S. Small-Cap Multi-Factor Index ETF (NASDAQ: PSC).

PSC’s underlying benchmark, the Nasdaq US Small Cap Select Leaders Index, “uses a quantitative model designed to identify equity securities (including growth and value stock) of small-capitalization companies in the Nasdaq US Small Cap Index (the ‘parent index’) that exhibit potential for high degrees of sustainable shareholder yield, pricing power, and strong momentum while adjusting for liquidity and quality,” according to Principal.

PSC YTD Performance

“We worry that an inconclusive election could unleash conflict. Officials in Pennsylvania have stated that it will take days before they can produce final results; if the election isn’t resolved during this period, protests could turn violent,” said AGF Investments’ Chief U.S. Policy Strategist Greg Valliere in a note on Monday.

PSC and Politics: Quality in Uncertain Times

These days, however, PSC’s quality lean is proving meaningful for investors. That’s important because smaller companies often sport higher leverage and are more rate-sensitive than their large-cap counterparts. Bolstering the case for PSC are improving small-cap earnings revisions, confirming the group has some earnings momentum.

“DataTrek Research co-founder Nicholas Colas also sees small-caps as an asset-class to buy during election-oriented volatility,” reports Reshma Kapadia for Barron’s.

The size factor is one of the most durable themes in the factor space, but many investors often overlook the benefits of focusing on higher-quality small-cap equities.

While the quality factor often trades at a premium to value, quality stocks are usually less volatile than traditional broad market strategies, indicating some overlap with the low volatility factor.

“This unknown will cast a shadow over both large-caps and small-caps, but the latter should snap back stronger once the winner becomes apparent especially if Congress passes more fiscal stimulus to help spur U.S. consumer spending,” notes Colas.

For more on multi-factor strategies, visit our Multi-Factor Channel.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.