Fears of an all-out trade war have frazzled investor nerves, as indicated by the large drops across major US equity indexes.
But before investors exit the stock market entirely, Morgan Stanley wants them to know that there is a safe haven of sorts for equities, buried among the market wreckage.
The stocks in question are known as “small caps,” or companies with meager market values, at least relative to benchmarks. Often overlooked when more actively traded mega-cap shares are soaring, Morgan Stanley argues their fundamental picture is compelling.
First off, since small cap corporations are usually more domestically focused than their larger peers, they’re better positioned to benefit from the nationalistic tax cuts afforded by the GOP tax law. Those tax savings trickle down to a company’s bottom line, improving the prospects for earnings growth.
Secondly, Morgan Stanley points out that small caps are also well-positioned to see a positive effect from business-friendly deregulation.
Largely piggybacking off the boost provided by these two dynamics, small caps have crushed the broader market so far this year. Their dominance can be seen in this chart, which shows that a pair of small cap indexes (represented by the two blue lines) has dominated the S&P 500.
But this conversation is null and void without a discussion of what the market’s latest and most threatening flashpoint — the escalating global trade war — means for small caps.
Luckily for investors considering a small-cap investment, Morgan Stanley finds that they’re less vulnerable to what it describes as “anti-trade rhetoric.” This once again comes back to the comparatively small international exposure small caps have.
In the end, small caps feature a compelling trifecta of positive attributes, offering a viable option for investors who want to stay invested in stocks, but want to be less exposed to President Donald Trump‘s latest trade headlines.
So with all of that established, are small caps still a good bet, despite already destroying benchmarks for much of this year? Morgan Stanley says yes. And it all comes down to growth.
“While the relative outperformance of small caps we have seen is a lot, forward growth expectations indicate it is likely to continue,” Mike Wilson, the firm’s chief US equity strategist, wrote in a client note. “The growth differential between small and large caps may be widening even further from here which should extend the relative outperformance.”
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