By Lewis Krauskopf
NEW YORK (Reuters) – As investors look for assets that will shine under Donald Trump's presidency, one corner of the U.S. stock market expected to benefit from Republican policies has been stumbling.
Shares of smaller US companies have been under pressure, with the small-cap Russell 2000 last week marking a 10% correction from its November highs. The S&P 500, the benchmark for large-cap companies, fell less than 3% in that time.
Trump, who will be inaugurated for his second term on Monday, is expected to back an agenda that promotes domestic economic growth, increasing the appeal of small-cap stocks.
But the group encountered a serious headwind in recent weeks: the possibility of higher interest rates than previously expected, which could raise borrowing costs that hit smaller companies particularly hard.
“With more pro-growth policies, small caps tend to do better in theory when the economy is stronger,” said Keith Lerner, co-chief investment officer at Truist Advisory Services.
“You almost had this tug of war,” Lerner said. “On one side, stronger growth should be good for small caps. On the other side, high interest rates are negative.”
Broadly speaking, small caps and equities gained some relief this week from an upbeat inflation report that muted rising Treasury yields.
The focus on small caps comes as investors look for “Trump trades” that have room to run.
The overall stock market has given up some gains since Trump's victory on Nov. 5, when investors were enthused by his pro-growth agenda to the benefit of equities in general. The S&P 500 is up 3% since the election.
Some Trump trades continue to thrive. Shares of Tesla, led by Trump supporter Elon Musk, have gained over 60% since November 5. Bitcoin, which is expected to benefit from a friendlier crypto regulatory environment, is up over 40%.
Small caps, however, have pulled back. The Russell 2000 index rose nearly 6% on the day after Trump's victory. Later in November, it hit its highest closing level in three years. Now the index has changed little since the election.
Expecting fewer interest rate cuts this year has dampened sentiment for small caps, with the Federal Reserve in December predicting less easing as it raised its estimate for inflation in 2025.
Treasury yields have increased. This week, the benchmark 10-year yield hit a 14-month high.
Smaller companies “tend to have larger debt loads … so not having the follow-through with lower interest rates is something that kind of pours some cold water” on hopes for small-cap strength, Yung-Yu said Ma, chief investment officer at BMO Wealth Management.