US small-cap stocks face selling pressure

NEW YORK (Reuters) – US small-cap stocks, highly sensitive to the fate of US President Donald Trump's policy ambitions, may face more selling pressure, leaving small-cap investors scrambling for quality names and more resilient sectors.

Small-caps, which are more reliant on US policy and economic conditions than are large multinationals, have fallen recently on rising doubts that Trump can deliver on pro-business promises such as tax cuts.

After outperforming in late 2016 after Trump's election, the S&P 600 index of smaller companies has fallen 1.4 percent in 2017 while the Russell 2000, which includes smaller firms, is up 1.4 percent versus the S&P 500's 9.2 percent rise.

With Russell 2000 and S&P 600 multiples above historical averages, small-cap investors are carefully picking their steps.

"There's a lot of value in small-cap land if you can look through the rubble," said St. Denis Villere III, portfolio manager at Villere & Co. in New Orleans, LA.

Some strategists are bearish on the small-cap sector as a whole, citing a patchier earnings outlook than for multinationals as well as doubts about Trump's agenda.

And small-cap indexes, which are typically more volatile than the S&P 500, may face high volatility in coming months as US lawmakers debate controversial issues such as the debt ceiling.

Smaller companies are “much more at risk than the large and more internationally exposed companies,” according to Michael Purves, chief global strategist at Weeden & Co., who cited concerns about the lack of a “cohesive mood” in Washington.

The S&P 600 price/earnings ratio is currently 19.7 compared with its long-term average of 17.3, while the Russell 2000 forward is 25.4 compared with its 21.3 historical average.

As a result, Jefferies equity strategist Steven DeSanctis says, the Russell 2000 could fall 10 percent or more, bringing it below where it was before Trump's Nov. 8 election as valuations are high and "volatility is on the rise."

The bearishness is sending investors to seek value in specific small-cap sectors and stocks that still look cheap but have strong growth prospects.

For example smaller financial and information technology stocks are strong value contenders while utilities and consumer staples stocks are out of favor among many investors.