The smallest companies in the US stock market have gotten the biggest boost from President Donald Trump’s proposed corporate tax cut, and investors see no end in sight for the rally.
Their confidence is manifesting itself in a lack of hedging. Investors are paying the least since the start of the eight-year bull market to protect against losses in the Russell 2000 index of small-cap stocks.
With the gauge just two days removed from a record high, this apparent lack of concern is a highly bullish signal. It’s already surged 19% since the presidential election, 7 percentage points more than the S&P 500, which hasn’t done too shabby in its own right.
Investors don’t seem keen to stop there. They piled more than $4 billion into an exchange-traded fund tracking the Russell 2000 over the week ended April 26, the biggest five-day inflow since right after election.
The logic behind the surging popularity of small-caps is that the group makes most its their money domestically, thereby positioning it to benefit more from a lower corporate tax rate.
They stand in contrast to larger multi-national corporations, which are able to defer taxes on overseas profits, and theoretically wouldn’t see as much of an immediate windfall from a tax cut.
Small-caps aren’t taking their fortune for granted. As Bloomberg’s Drew Singer points out, the companies are taking advantage of investor goodwill to tap capital markets. He notes that of the $47 billion raised by public companies this year, well over half of that has been by companies with less than $5 billion of market value.
Not everyone shares their optimism.
To Bank of America, the quick climb higher for small-caps marks the “last bout of optimism” for trades tied to expectations of Trump policy. The group is now trading at “tech bubble-like valuations,” a group of the firm’s analysts led by Dan Suzuki wrote in an April 27 client note.
Still, traders are paying the lowest premium since May 2009 to protect against a 10% increase in the Russell 2000 over the next three months, relative to wagers on a 10% increase, Bloomberg data show. In other words, investors haven’t been this unhedged on small-caps since two months after the bull market started.
Business Insider / Andy Kiersz, data from Bloomberg