Gloom around small-cap stocks

OPTIMISM is souring around small-cap stocks for some investors, with a host of factors conspiring to up-end gains that have taken them to record highs.

Small-caps, which led the market’s rally just after the November 8 election of Donald Trump as US president, are facing weak earnings forecasts, little progress on tax reform and recent outflows.

“We have downside risks here. Earnings numbers aren’t great, and valuations are… pretty rich,” said Steven DeSanctis, equity strategist at Jefferies. Investors had expected the administration of Republican Trump, with his promises of aggressive tax cuts and a healthier US economy, would be a boon for small-caps, which tend to be more domestically focused. Doubts Republicans so far have been unable to push through bills to repeal and replace the Affordable Care Act. That has raised doubts about the likelihood of any tax reform this year. Smallcaps have higher effective tax rates – about 32 percent versus 26 percent for large-caps, a note from Nuveen Asset Management showed.

The performance the Russell 2000, a widely used gauge for small-caps, and the small-cap S&P 600 has lagged that of large-caps so far this year, but the Russell is up 20.3 percent since the election compared with a gain of 15.3 percent for the S&P 500. All three indexes hit record highs in recent sessions, just as the earnings reporting period was getting under way.

In the small-cap energy sector, services and equipment companies continue to be affected by project cutbacks by larger companies. The smallcap outlook is in contrast to expectations for another quarter of strong profit growth for the S&P 500 and a sharp year-overyear jump in large-cap energy.