Small cap stocks have underperformed large caps this year, by a wide margin. However, with renewed talk about tax reform in Washington, is now the time to buy?
Looking at a chart going back to last year, shows small caps really haven’t been too far behind large caps. This chart compares the S&P 500 index to the Russell 2000 index, going back a year. The indexes have a similar return. The Russell 2000 has just been more volatile.
Smaller companies tend to pay higher taxes, so if Congress is serious about lowering them, it will give that group the biggest boost. The fate of small caps has been tied to the prospects of that happening, since Donald Trump and a Republican congress was elected last year.
Small caps jumped, once there was a prospect of lower taxes. Unfortunately, there has been a lot of issues that have hampered the ability of Congress to get tax reform done. As confidence has waned, so has the value of small caps.
Also, a weaker dollar has helped large cap stocks earnings. This is because large caps tend to do a lot of international business. Meanwhile, small caps, which are mostly domestically based, have had flat earnings. As a result, large cap stock prices keep chugging higher, while small caps have fallen off a cliff.
There are signs that the U.S. economy is beginning to pick up steam. This week, there was a 3.0% GDP print and a rise in consumer confidence. This would be a positive for small caps. I am not worried about the nascent rise in prices, the CPI and other indicators are showing. I believe prices will begin to rise and interest rates too as the economy picks up even more. I am looking at copper prices, which just hit a three year high and other commodity prices beginning to rise. These things will feed through.
I have advocated buying well run small cap bank stocks. Long term rates have backed up a little bit, but the more positive business environment is still in tact. A lot of the regulations that have been holding back growth, have been relaxed. As I pointed out above, long term rates should eventually move higher. Resulting in steepening yield curve, which is good for these stocks.
However, the bigger picture is that this is not just a U.S. story. Growth is growing internationally. I would rather be involved in companies that are set to benefit from emerging economies, as I think those places are set to grow the most. I think Caterpillar (CAT) stock is a better stock to own, than BancFirst Corporation (BANF), in this environment. Although, I like both stocks.
Yes small cap stocks will do well, if Congress gets its act together, and passes tax reform, that cuts taxes. For that reason, it would make sense to own shares in a good small cap stock, right now. Otherwise, companies that operate internationally or emerging market stocks make more sense to me.