Small-caps are back in vogue this September. So far this month, the Russell 2000 index of small capitalisation stocks has gained nearly 3%, outpacing the other major benchmarks of the US stock market. These investments had been all the rage late last year as one of the more popular aspects of the so-called "Trump trade," the name given to the areas of the financial markets that rallied after Donald Trump's election last year.
This was partly because smaller companies benefit disproportionately from corporate tax cuts, one of the US president's pledges. Small companies are more domestically focused and often pay higher taxes as they tend not to have cash flows in countries with different tax regimes, but when hopes around Mr. Trump's agenda faded during the year, so did investor interest in small-caps.
So what has changed? One reason this group is drawing buyers now is simply a bit of catching up. Year to date, this S&P 500's performance is about double the Russell 2000's, at nearly 12% versus about 6%. Another is that the political rhetoric around a US tax package is ratcheting up again, even if it remains unclear whether politicians can manage to pass anything.
What's more, some investors are beginning to believe that the US dollar may be bottoming out for now. Dollar weakness has helped the earnings of multinationals, which make revenues around the world. The slightly more hawkish tone from the Federal Reserve is supportive. The US Central Bank this week painted a broadly optimistic picture for the economy ahead of an expected rate rise in December.
Again, small companies are closely linked to the health of the US economy. Michael Underhill, chief investment officer at Capital Innovations, also notes that US small-caps have historically outperformed large-caps during periods of rising rates. According to FactSet, neither small- nor large-caps are cheap these days. In terms of valuation, small-caps for their part trade at nearly 25 times forward earnings after the recent gains, above both the 5- and 10-year averages, which means these trends must continue for small-caps to stay in style.