Lewis Krauskopf
NEW YORK (Reuters) - A corner of U.S. stocks expected to benefit from Republican policies is struggling as investors seek assets that have thrived during Donald Trump's presidency.
Share prices of small U.S. companies have been under pressure, with the small-cap Russell 2000 index retreating 10% from its November high last week. The S&P 500, the benchmark for large-cap stocks, fell less than 3% at the time.
Trump, who takes office for a second term on Monday, is expected to support an agenda to boost domestic economic growth, increasing the appeal of small-cap stocks.
But the group has encountered serious headwinds in recent weeks: a higher-than-expected interest rate outlook that will lead to higher borrowing costs and hit small businesses particularly hard.
"With more pro-growth policies in place, in theory, small-cap stocks tend to do better when the economy is stronger," said Keith Lerner, co-chief investment officer at Truist Advisory Services.
"You almost have a tug of war," Lerner said. "On one hand, stronger growth should be good for small-cap stocks. On the other hand, high interest rates are negative."
Small-cap stocks and stocks generally found some relief this week as encouraging inflation reports calmed soaring Treasury yields.
There's a focus on small-cap stocks as investors look for "Trump trades" with room to run.
Overall stocks have given up some gains since Trump's victory on Nov. 5, when investors were excited about his pro-growth agenda, which broadly benefited stocks. Since the election, the S&P 500 is up 3%.
Some Trump deals continue to thrive. Tesla shares have risen more than 60% since November 5, led by Trump supporter Elon Musk. Bitcoin is expected to benefit from a friendlier regulatory environment for cryptocurrencies, rising more than 40%.
However, small-cap stocks have pulled back. The day after Trump's victory, the Russell 2000 soared nearly 6%. Later in November, the index hit its highest closing level in three years. The index has changed little since the election.
Expectations of smaller rate cuts this year weighed on sentiment among small-cap stocks, and the Federal Reserve in December raised its inflation forecast for 2025, anticipating less easing.
Treasury yields soared. This week, the benchmark 10-year Treasury yield hit a 14-month high.
CEO Yung-Yu Ma said smaller companies "tend to carry larger debt loads... so not getting a follow-up with lower rates is dooming hopes for small-cap strength." A basin of cold water." Investment Officer, BMO Wealth Management.
The Russell 2000 surged after Trump's election in 2016, and the index continued to outperform the S&P 500 in the year after his first victory, rising 24%, while the large-cap index gained 21%.
Sameer Samana, senior global market strategist at Wells Fargo Investment Institute, said the prospect of less regulation and more domestic business under Trump should benefit smaller companies, These companies tend to have more of a U.S. focus on their business than larger multinationals.
Samana said that while the group's prospects have improved under Trump compared with his predecessor, Joe Biden, the incoming president's support for tariffs could hurt small businesses if they disrupt supply chains. Come to question.
"Under the Trump administration, there are some things that will be helpful ... but there will also be some negative effects," Samana said.
Small-cap bulls are hoping to catch up. The S&P 500 is up nearly 50% over the past two years, more than double the Russell 2000's gain.
However, small-cap stocks may face headwinds if interest rates continue to rise. Truist's Lerner said small-cap indexes tend to be more weighted toward financial and industrial sectors, which are relatively more sensitive to rising interest rates and inflation.
At the end of 2024, the Russell 2000 had a 37% weighting in these two sectors, compared with about 22% in the broader S&P 500.
Bank of Montreal's Ma said Trump's arrival presents opportunities for small-cap stocks, "but the outperformance thesis may depend more on a favorable interest rate environment."
(Reporting by Lewis Krauskopf; Editing by David Gregorio)