Three Big Threats To Small Caps

Tyler Durden's picture

Authored by Steven Vanelli via Knowledge Leaders Capital blog,

With some exceptions, smaller-cap stocks in the US tend to pay higher taxes than their larger-cap peers. As such, speculation that corporate tax rates may be cut has stoked the performance of US small caps recently.

[ZH - and in recent days - tax hope appears to have faded fast...]

In addition to the concern that tax reform and/or tax cuts may get stalled, there are three other factors that we think investors should consider when evaluating small caps in the US.

First, the relative performance of US small caps, compared to the developed world has been highly correlated to changes in the size of the Fed’s balance sheet.

More so than large cap stocks, the relative performance of small caps has tracked successive rounds of QE quite closely. As can be seen in the chart below, where we compare the relative performance of US small caps to our KLSU Developed Market Index, small caps have been in a sideways channel since the end of QE3. The concern here, of course, is that as the Fed moves to shrink its balance sheet, the relative performance of liquidity-sensitive small caps may suffer.

Second, generally US small caps outperform the developed global equity markets when the developed markets are outperforming the emerging markets.

In the chart above, the red line, fixed to the right axis and inverted, is the relative performance of the MSCI Emerging Markets Index compared to the MSCI World Index. If EMs continue to outperform DMs, breaking out of the 2014 resistance, this may telegraph more weakness ahead for US small caps.

Lastly, since 2009 US small cap stocks have exhibited a close relationship with the US budget deficit as a percent of GDP.

While the budget deficit shrank from over 10% of GDP in 2009 to less than 3% of GDP by 2014, US small caps outperformed global developed equities by 35%. They are dead flat since. As the budget is slowly widening out again, it appears small cap relative performance is rolling over with it. Ironically, should the US pass a tax cut that widens the deficit, this may be a greater negative for small caps than any positive effects of lower tax rates.

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lester1's picture

Bitcoin is a threat to everything. Fiat money is pouring into the cryptos and it's just the beginning.

Dr. Engali's picture

Applying fundamentals to a centrally planned eCONomy. Cute.

LawsofPhysics's picture

The only technical analysis you need to know is that since 2008/2009 The Fed has unleashed enough new "money" to increase the money supply by 16 fold...  ...we all know that none of that is making it to main street, but it has to go somewhere and the bankers and financiers who got it (and still have access to billions at less than one percent) need to put it somewhere if there really is going to be a "pull-back" etc.

Watch the cryptos, one hypothesis is that this is the "escape valve" for all this free money (that was supposed to go to main street).

 

Interesting times...

"Full Faith and Credit"

shizzledizzle's picture

Uh oh... Benny boy calling for more "Temporary" shit... LOL! "We can't cook inflation numbers anymore because no one is buying it, gotta move on to price controls!"

The Duke of New York A No.1's picture

FED proxies sell VIX = Sheep don't panic = balance sheet reduction goes smoothly = Janet "the Hero".

Fantasy Free Economics's picture

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Small Cap indexes are extremely easy to goose.

ttp://quillian.net/blog/why-the-stock-market-always-goes-up/

Negative articles draw shorts into the sector making it even easier.

James Quillian

Fantasy Free Economics