Small caps set to benefit more under Trump administration
tax rate the key driver (and lack of foreign revenue)
IWM’s “have become a show me story. The main DRIVER supporting small cap is Economic Indicators & Policy, as small tends to lead when real US GDP is 2-3% range. Small caps also benefit from protectionism due to lower international exposure (19% of revenues in the R2000 vs. 31% for the S&P 500) and the pursuit of a lower corporate tax rate in Washington (we estimate the R2000’s effective tax rate is 32% vs. 26% for the S&P). The small/large trade has also been positively correlated with interest rates since the Financial Crisis, meaning further increases in yields are likely to be accompanied by small cap outperformance. Retail Money Flows initially favored small cap post-Election, with inflows returning, but have started to trend positive for large again in the latest ICI update (we are watching trends here closely). Importantly, Valuations no longer support small over large, as our model is nearly back to neutral (though not expensive yet). On Investor Sentiment, a higher VIX should not derail small cap outperformance for the year as a whole, as long as the average for the year remains subdued (i.e. <25).