Brocker.Org: Small Caps Break Out After Trump Tax Proposal


Small cap stocks hit fresh all-time highs after President Trump unveiled plans to overhaul corporate taxes. The iShares Russell 2000 Index ETF (IWM) reached an all-time high of $141.82 and the iShares S&P SmallCap 600 Index (IJR) hit a record of $71.17 earlier this week.

President Trump’s corporate tax overhaul would cut the tax rate for owner-operated businesses to 15% – a move that could help small-cap stocks more than large-cap stocks. After all, multinational large-cap companies defer U.S. taxes on profits earned overseas, but small-cap companies make most of their revenue from domestic sales. The Russell 2000 outperformed the S&P 500 in November and has seen renewed optimism with the proposal.

From a technical standpoint, the iShares Russel 2000 ETF recently broke out from trend line resistance at around $137.50 and reached its R1 resistance at $141.16. Traders should watch for a further breakout to R2 resistance at $144.84 on the upside or a move back down to retest its trend line support and pivot point at $136.78. The RSI suggests the index is temporarily overbought, while the MACD recently crossed over into positive territory.

The primary driving force behind the index will be the remainder of first-quarter earnings season and the prospect for President Trump’s tax plan to make it through Congress. Since the plan would add to the federal budget deficit, the president could face an uphill battle in convincing Democrats and even Republicans to support the corporate tax cuts. Any hints at resistance could send small-cap stocks lower from these levels.

The good news is that first quarter earnings have been very strong. According to FactSet’s Earnings Insight, 76% of S&P 500 companies have beat their mean EPS estimates and 59% have beat their mean sales estimates with 6% of companies reporting. The average growth rate for the first quarter among these companies was 9%, which has yielded a forward P/E ratio of 17.4x – above the 15.1x 5-year average and the 14x 10-year average.

Charts courtesy of Author holds no positions in stocks mentioned except through passively-managed index funds.