Small caps are losing their immunity to trade jitters

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
By  Bloomberg

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)

Latest News

Judge OKs more than $90 million in settlement money for GWG investors
Judge OKs more than $90 million in settlement money for GWG investors

Mayer Brown, GWG's law firm, agreed to pay $30 million to resolve conflict of interest claims.

Fintech bytes: Orion and eMoney add new planning, investment tools for RIAs
Fintech bytes: Orion and eMoney add new planning, investment tools for RIAs

Orion adds new model portfolios and SMAs under expanded JPMorgan tie-up, while eMoney boosts its planning software capabilities.

Retirement uncertainty cuts across generations: Transamerica
Retirement uncertainty cuts across generations: Transamerica

National survey of workers exposes widespread retirement planning challenges for Gen Z, Millennials, Gen X, and Boomers.

Does a merger or acquisition make sense for your firm? Why now is the perfect time to secure your firm’s future
Does a merger or acquisition make sense for your firm? Why now is the perfect time to secure your firm’s future

While the choice for advisors to "die at their desks" might been wise once upon a time, higher acquisition multiples and innovations in deal structures have created more immediate M&A opportunities.

Raymond James continues recruitment run with UBS, Morgan Stanley teams
Raymond James continues recruitment run with UBS, Morgan Stanley teams

A father-son pair has joined the firm's independent arm in Utah, while a quartet of planning advisors strengthen its employee channel in Louisiana.

SPONSORED RILAs bring stability, growth during volatile markets

Barely a decade old, registered index-linked annuities have quickly surged in popularity, thanks to their unique blend of protection and growth potential—an appealing option for investors looking to chart a steadier course through today's choppy market waters, says Myles Lambert, Brighthouse Financial.

SPONSORED Beyond the dashboard: Making wealth tech human

How intelliflo aims to solve advisors' top tech headaches—without sacrificing the personal touch clients crave