Small Caps Are Not An Ideal Safe Haven During Trade War

For investors looking for ideal safe haven assets during the U.S.-China trade war are better off looking at large cap equities over small cap equities, according to Jill Carey Hall, the resident small cap stock expert at Bank of America. Hall said that small cap fundamentals are suspect and as such, should be avoided if a prolonged trade war continues.

“A lot of these companies are suppliers to the big multinationals. Many of them have been highlighting the impact of trade on calls this earnings season,” said Hall. “A lot of these companies might not be able to be as nimble about shifting their supply chains or pricing that through.”

The Russell 2000–the index primarily associated with small cap equities–is up 21 percent since December’s sell-off during a volatile fourth quarter in 2018. However, the index is in correction mode with a drop of 12 percent after hitting a high last summer.

“Small cap earnings have been coming in in-line with expectations. You’ve seen much fewer beats. You’ve seen negative earnings growth,” said Hall. “Typically, you would think of small caps as higher growth companies, but expectations have been really ratcheted down.”

Small cap equities were practically neck and neck with large cap equities during the month of April. Year-to-date performance for U.S. equities have been fueling both large cap and small cap stocks, as both jockeyed for position during that month.

Thanks to a more accommodating central bank in terms of interest rate policy, the markets have been able to fend off other macro fears like slower global growth. More help came from the U.S. economy rebounding in the first quarter this year, as it beat analysts’ expectations of 2.5 percent growth with a 3.2 percent growth number.

The GDP figure represents the strongest rate of growth for the first quarter in four years and matches the 3.2 percent growth experienced a year ago.

“It has undeniably been quite an extraordinary first four months of the year for broad U.S. markets,” wrote David Mazza, Managing Director and Inkoo Kang, Vice President in Direxion’s latest Relative Weight Spotlight. “The Russell 1000 gained 18.60% (total return) through April, and Small Cap stocks, as measured by the Russell 2000, provided 18.48% through the end of April. To put that into perspective, the last time we saw both Large Caps and Small Caps provide greater than 18% total returns over four months’ time was in December of 2010.

“In terms of seasonality, 2019 provided the strongest January-to-April return for Small Cap stocks since 1991, and the strongest January-to-April return for the Russell 1000 since 1987. As a result, volatility calmed dramatically: the average for the CBOE Volatility Index throughout the first four months of 2019 was 15.56, which was notably lower than the 19.17 average throughout the last four months of 2018.”

From a year-to-date standpoint, it’s the S&P 500 edging the Russell 2000 with the edge, but can this trend sustain itself?

For investors looking for continued upside in large cap equities over small caps, the Direxion Russell Large Over Small Cap ETF (NYSEArca: RWLS) offers them the ability to benefit not only from large cap equities potentially performing well, but from their outperformance compared to their small cap brethren.

Conversely, if investors believe that small cap equities will outperform large cap equities, the Direxion Russell Small Over Large Cap ETF (NYSEArca: RWSL) provides a means to not only see small cap stocks perform well, but a way to capitalize on their outperformance versus their large cap brethren.

For more relative market trends, visit our Relative Value Channel.