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By Lisa Pauline Mattackal
(Reuters) – U.S. small-cap shares have surged to close document highs following Donald Trump’s presidential election win, however some buyers are cautious of chasing the rally as they worry his insurance policies might drive a resurgence in inflation, hurting the rate-sensitive sector.
The Russell 2000 index has soared almost 31% because the election on Nov. 5, outperforming beneficial properties in main indexes on expectations that Trump’s proposals to chop taxes, lower rules and enhance tariffs would elevate domestically targeted small caps.
However some analysts and portfolio managers consider the insurance policies might drive up the price of items and stoke inflation, derailing the sector’s efficiency, significantly if renewed inflationary stress prompts fewer-than-expected Federal Reserve rate of interest cuts.
Buyers have already dialed again expectations for price cuts in 2025, and that has pushed Treasury yields to multi-month highs.
“We expect (inflation) might be the largest under-appreciated threat by markets,” stated Sameer Samana, senior international market strategist at Wells Fargo Funding Institute (WFII), who has a impartial score on small caps.
“Proper now, giant caps appear greater high quality (and have) higher earnings development, it is simply very troublesome to drop right down to smalls once they do not have a lot going for them proper now.”
Small-cap corporations have a tendency to hold extra debt on their steadiness sheets, which suggests a rise in rates of interest might drive up borrowing prices for them and make servicing their debt harder, analysts say.
Jamie Battmer, chief funding officer at Inventive Planning, stated Trump’s tariffs would pressure small caps to face a “delicate balancing act.”
The Russell 2000 has gained about 19% in 2024, nevertheless, lagging the benchmark S&P 500’s 26% rise and the Nasdaq’s 28% achieve.
Regardless of the index’s underperformance this yr, valuations are excessive. The Russell 2000 is buying and selling at round 28.3 occasions ahead earnings, in response to information compiled by LSEG, in contrast with S&P 500’s 22.7.
“What we’re specializing in is earnings and high quality – and small caps do not actually match that,” stated Jim Caron, chief funding officer, cross-asset options at Morgan Stanley Funding Administration.
Ryan Dykmans, chief funding officer at Dunham & Associates Funding Counsel, stated that whereas his agency has been including to small-cap holdings, it has targeted on corporations with much less debt.
“If charges are going to remain as excessive as they’re in the present day for an additional yr, you are going to see a whole lot of small cap corporations simply burn out,” stated Dykmans, suggesting it could be troublesome for them to pay down curiosity on their debt or take out new loans.
