By: Tom Goodwin, senior research director
On November 9, a day after the election of Donald Trump as president, the phenomenon known to the media and others as the “Trump Trade” came into being. The president-elect’s proposed package of tax cuts, infrastructure spending and deregulation was expected to boost aggregate demand and business investment spending. US stocks rose substantially with small caps leading the way. However, half way through 2017 expectations that the president’s proposed agenda will get through Congress intact have faded, yet the market has continued its upward march. So what happened to the Trump Trade?
It’s worth noting that the rise has not been uniform across the market. From election day 2016 through the end of the year, the value of the small cap Russell 2000® Index increased by an impressive 14.1%, while the value of the large-mid cap Russell 1000® Index increased by a smaller, although still significant, 5.6%. There are some plausible explanations for why small caps were more affected than large caps by Trump’s election.
First, smaller cap companies typically only operate within the US tax jurisdiction making them more sensitive to changes in US corporate tax policy. The Trump proposal was to cut the corporate rate from 35% to 15%. In addition, US infrastructure spending and Trump’s “America First” trade policy are both more likely to have an impact on domestically focused companies—again, typically smaller cap firms.
But sector returns seem to support this conclusion only to the end of 2016. The chart below depicts Russell 2000 Index sector returns in excess of the overall Russell 2000 Index, from November 8 to the end of 2016, and then year-to-date through June 16, 2017.Those four sectors are Energy, Financial Services, Materials & Processing and Producer Durables, all sectors that could be expected to benefit from less regulation and more infrastructure spending. The sectors are ordered from highest to lowest index returns in the period immediately following the election. Note that all four of these sectors have underperformed the Russell 2000 Index since the beginning of 2017.
Performance of Russell 2000 Index sectors compared to Russell 2000 Index
Source: FTSE Russell. Data as of June 16, 2017. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
Also of note is that the three sectors that most underperformed right after the election—Technology, Utilities and Health Care—have reversed to become the only outperforming sectors since the beginning of this year. These three sectors were the least likely to be affected by Trump's agenda or, in the case of Health Care, were possibly even negatively impacted by it. This suggests that the Trump Trade may have partially or wholly reversed.
Yet the Russell 2000 Index as a whole has continued to rise by 3.5% so far this year, so something else must be at play. In finance, we tend to use historical trends to help us understand the present, so I thought it would be useful to look at the history of the small cap cycle to see where we might be in that cycle now.
Starting in 1979, looking back at the peaks and troughs of the Russell 2000 Index and the respective bear and bull markets that followed, we can get an idea of the length and size of the average cycles. From this analysis it’s clear that bear markets have been historically much shorter than bull markets while the historical index returns of bull markets have been substantially higher than the negative returns experienced in bear markets. Most notably for this particular analysis is that the average return of past bull markets was 133.8%, while the median was 106.8%.
To get a better understanding of where the small cap cycle is now, we have to go back to the beginning of 2016. As we can see in the chart below, the Russell 2000 Index reached its lowest point on February 11, 2016. After the presidential election, this small cap index experienced a substantial boost through the end of 2016. Since then, there has been a modest but overall positive index return. Currently the Russell 2000 Index is up 46.5% in the 332 trading days since the 2016 trough – well below both the average and median of previous bull markets. Based solely on history, it would appear that the Russell 2000 Index is only in the middle of a typical bull market phase.
Russell 2000 Index value from to June 16, 2017
Source: FTSE Russell. Data as of June 16, 2017. Past performance is no guarantee of future results. Returns shown may reflect hypothetical historical performance. Please see the end for important legal disclosures.
So there you have it. On the one hand there is evidence that the Trump Trade has already partially or completely reversed. On the other hand, there is evidence that the small cap market has been buoyed up by being somewhere in the middle of a typical bull market cycle, independent of whatever is emanating from Washington, D.C. It will be interesting to see what unfolds next...
For more analysis on stock market reaction to new presidents, please see our blog What difference does 100 days make? For more information on recent small cap sector performance: Market turns to growth stocks in 2017.
 Source: FTSE Russell. US date format: Data as at June 16, 2017. Hypothetical data may have been used. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
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