Small caps are losing their immunity to trade jitters

Russell 2000 index of small-cap stocks has underperformed global equities three days in a row

Jun 27, 2018 @ 11:31 am

By Bloomberg News

A shelter from the storm is starting to sprout leaks.

Bearish sentiment is growing on the Russell 2000 Index of small-cap stocks, a group that had seemed relatively immune to the trade-tariff saber-rattling that's recently cast a pall over the outlook for global commerce. This index, composed of U.S. companies that generate the bulk of their revenue domestically, has underperformed global equities for three consecutive sessions after hitting a record high relative to the MSCI World Index last week.

"We've been on the wrong side of the Russell (leaning short) for almost a month, but the last three days have erased three weeks of gains," Peter Cecchini, the global chief market strategist at Cantor Fitzgerald, wrote in a note Tuesday. "It's time to press the short."

Naufal Sanaullah, the chief macro strategist at EIA All Weather Alpha Partners, outlined two likely scenarios for small-cap stocks going forward. One is some resolution of trade angst that would lead to a period in which U.S. multinationals and emerging markets fare well. The alternative is that trade barriers start to weigh on economic activity stateside, fueling weakness in domestic-linked stocks that have largely been shrugging off the clash over commerce between the U.S. and China.

"A combination of stretched positioning and increasing fears of second- and third-order effects of trade conflict are leading investors to reconsider the immunity against negative trade headlines that recently-outperforming domestic-facing cyclicals possess," he said.

Mr. Sanaullah favors relative value trades that take advantage of the low implied volatility for U.S. small caps as well as large-cap tech stocks.

Typically, implied volatility for the Russell 2000 Index trades at a sizable premium to that of the S&P 500 Index, in line with the notion that smaller stocks tend to display larger swings than larger ones. However, since the February stock rout, the spread between implied volatility for the two gauges shrank to — and has remained at — historically low levels.

The upshot: Fears of escalating trade tensions may have been meaningful to markets for longer than implied by the performance of broad U.S. equity market.

"If the 'trade war' fades, then a reversal of this relationship could be in the cards," wrote Andrew Lapthorne, the global head of quantitative strategy at Societe Generale, flagging the elevated corporate leverage as cause to not be "keen" on small caps.

(More: Concerns about trade war play out in ETF flows)

0
Comments

What do you think?

View comments

Recommended for you

Featured video

INTV

The bizarro world of DOL and SEC rule supporters

Managing editor Christina Nelson talks with senior reporter Mark Schoeff Jr. about why groups that supported the Labor Department's fiduciary rule oppose much of the SEC advice package, and vice versa.

Latest news & opinion

10 countries where your clients should consider retiring

These countries offer the greatest security for their retirees, according to the 2018 Natixis Global Retirement Index.

10 most affordable U.S. cities for renters

Here are the U.S. cities that are most affordable for renters, according to Business Student.com, which compared the cost of rent to average salaries.

9 best - new - financial adviser jokes

Scroll through for nine new financial adviser laughs.

Captrust, prominent 401(k) advice firm, ramps up its wealth management business

Captrust wants to grow annual revenue from wealth management to 50% from 30% over the next five years.

Fidelity CEO says zero-fee funds aimed at expanding its universe

Johnson says way to prosper in financial services is 'by building relationships.'

X

Hi! Glad you're here and we hope you like all the great work we do here at InvestmentNews. But what we do is expensive and is funded in part by our sponsors. So won't you show our sponsors a little love by whitelisting investmentnews.com? It'll help us continue to serve you.

Yes, show me how to whitelist investmentnews.com

Ad blocker detected. Please whitelist us or give premium a try.

X

Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print