• First, a few things (besides renewed optimism over a 50 bps cut) went right for Small Caps last week.
• Second, we highlight our current, top-down US equity market read throughs from the domestic policy platforms of the Harris and Trump campaigns. The longer-term signal their platforms are sending is more interesting to us than the noise around any shorter-term policy related sector trades.
If you’d like to hear more, here’s another five minutes. Now, let’s jump into the details.
Starting With Takeaway #1: The Things That Went Right For Small Caps Last Week
We met with a number of Small Cap investors last week, who were keen to know our thoughts on their asset class. Our view has been:
are no longer cheap for the R:
And so we think much of the easy money from Fed cuts in Small Caps has been made, and that for Small Caps to see a sustained outperformance trade take hold, either a recession needs to occur (when Small Caps benefit from anticipation of cyclical recovery) or near-term economic tailwinds need to improve.
Even if the landing ends up being soft and Fed cuts are coming (something that normally sparks Small Cap leadership), we suspect a hot economy rather than a so-so economy is needed for this economically sensitive part of the equity market to embark on a longer-term outperformance cycle.
Small caps had a big move on Friday. The trigger was renewed optimism about a 50 basis point cut but it’s worth noting that a couple of other things went their way as well:
. Consensus:
2. The preliminary September reading for consumer sentiment on the University of Michigan survey surprised a bit to the upside and rose versus the prior month. This is good news for Small Caps which have been trading closely (on a yr/yr basis) with consumer sentiment trends in the post COVID era.
3. Third, inflows returned to Small Cap funds, outflows occurred from Large Cap, pointing to a deliberate rotation and attempt to move down market cap.
a. These were both driven by shifts in passive flows, which keeps us worried that the size trade will stay fickle.
Longer-term, the shift in GDP forecasts and consumer sentiment data makes us feel better about Small Caps. But in the very short-term, the flow data makes us worried that if a 50 basis point cut doesn’t come through on Wednesday (a view shared by RBC’s Rates Strategy and Economic teams), the fast money may be disappointed and Small Caps may take a short-term hit once again.
Moving on to Takeaway #2: Election Uncertainty Persists, While Domestic Policy Views Take Shape
Uncertainty emanating from the US election persists in the investment community. Harris has expanded her narrow lead over Trump in betting markets and national polls, while swing state polls for the Presidential race remain tight.
pling from Trump. For most of:
We continue to point investors to the seasonal playbook in election years, which highlights how equity markets usually falter in September and October and enjoy a relief rally once the event passes. Assuming we have a clear outcome shortly after election day (and a split or Republican Congress), we think that remains a reasonable way to think about how election dynamics may impact US equities through the year-end.
While last week’s debate did little to provide clarity on the domestic economic policy agendas of either candidate, which is key for the stock market. But investors have gotten some additional information on the domestic policy agendas of both camps in recent weeks. We compared the plan posted on Harris’ campaign website with the one posted on Trump’s and his recent economic speech in NYC, and outlined our own, preliminary US equity market read throughs.
For the non-US investors looking for short-term trades to make, the playbook we see right now is probably thinner than they’d like, at least according to our top-down approach.
• We think the conventional wisdom that Harris is better for Alternative Energy and Trump is better for traditional Energy remains one of the clearest and most sizable gaps between the candidates.
• Political risk to the Health Care sector seems low under both, but we see a bit more risk from Harris due to the focus on costs
• Both campaigns have articulated a number of consumer-friendly initiatives, but Harris’s platform seems friendlier to lower to middle income consumers, while Trump’s platform appears to be friendlier to the upper income consumers that have been propping up consumer spending of late.
of the headline rate prior to:
• We don’t have enough details on Trump’s proposals to properly understand sector and index implications yet, and found the comments he made in his recent NYC speech linking a 15% corporate tax rate to domestic production confusing in terms of what it says about the impact to S&P 500 profitability.
rms of performance during the:
The longer-term signals these plans are sending about where the country is headed was, frankly, more interesting to us. On paper these two candidates are talking about a lot of the same things: fighting inflation and keeping costs lower, stricter immigration policy, assisting lower end and middle-income consumers, pushing ahead with policies that support deglobalization like tougher trade policy.
Housing affordability and supply and education are being discussed by both.
Language from both is friendly to AI. Both seem likely to add to the deficit or keep it sizable, keeping investors who focus on that issue frustrated.
Regardless of outcome, these are all likely to stay in focus in the years ahead.
That’s all for now. Thanks for listening. And be sure to reach out to your RBC representative with any questions.
