“History doesn’t repeat itself, but it often rhymes.” A cliché in financial markets, but no less relevant because of it. The “surprising” surge in confidence among American smallcaps is no exception.
The chart below shows that confidence among small American businesses, measured by the NFIB Small Business Optimism Index, soared in November. You’d have to go back three and a half years to find the last time US smallcaps were this optimistic. It’s hard to see this apart from Trump’s victory, underpinned by his familiar slogan, “Make America Great Again.”
Especially when we rewind eight years. In November 2016, when the US learned that Trump would become president, the exact same thing happened. Fueled by Trump’s rhetoric about massive support for American businesses – which soon took the form of a global trade war – smallcap CEOs couldn’t contain their excitement.
There are two key points I’d like to make about this. First, cheerful CEOs of small American businesses don’t necessarily mean cheerful investors in small American businesses. In the first weeks after the 2016 election, the Russell 2000 Index, a benchmark for US smallcap performance, outperformed the S&P500 Index by almost 12 percent. This time, that outperformance was less than 5 percent.
In 2017, US smallcaps lagged behind the S&P500 Index by more than 6 percent. By the end of 2018, the post-election underperformance had grown to 13 percent. So, the first time around, “Make America Great Again” wasn’t a recipe for “making outperformance.” This time, the Russell 2000 Index has already given back some of its gains.
As I wrote last week, I don’t have much faith in Trump trades, let alone their ability to generate excess returns.
But there is good news. The sharp rise in small business sentiment likely means the chances of a recession are diminishing further. The United States is home to over 33 million small businesses, collectively accounting for just under half of total employment. If a CEO views the world through rose-tinted glasses, even temporarily, it makes layoffs less likely.
Moreover, there is a positive correlation with the ISM indices, which reflect sentiment among a broader group of companies. If employees at small businesses continue to spend confidently because their jobs feel secure, a significant portion of that spending benefits large companies. After all, you’ll eventually need to replace that iPhone with the cracked screen.
This brings me, finally, to the many lukewarm stock market forecasts I’ve seen over the past week. The “gurus” whose predictions align suspiciously closely with average long-term returns are, as always, too numerous to count.
Yet, with central banks ready to lower interest rates further and continued positive economic growth, the outlook seems fairly promising. Inflation remains a significant risk, of course, but if Trump manages to stoke the “animal spirits” a little more, the overall picture doesn’t look bad. Whether this means you should invest in US smallcaps, however, remains doubtful.
Jeroen Blokland analyses striking, topical charts on financial markets and macroeconomics in his newsletter The Market Routine. He also manages the Blokland Smart Multi-Asset Fund, which invests in stocks, gold, and bitcoin.