Last week all three major indices, S&P 500, DJIA, and NASDAQ all finished at all-time highs with weekly gains for three consecutive weeks. For the week, the S&P 500 rose 1.4%, DJIA up 1.5%, and the NASDAQ also was up 1.5%. Investors are aggressively buying stocks with the near certainty that Congress will support pro-business legislation that will prompt faster economic growth.
Barron’s article this weekend quoted the following:
Says David Waddell, chief investment strategist at Memphis-based Waddell & Associates. If the current trend is for GDP growth of about 2.8%, “that could go to 4.5% pretty quickly”. “That’s why there’s so much euphoria. We’ve seen high piles of cash coming into the market. People were so terrified of the election, and now all that cash is coming back in a hurry. That’s why the market’s not going down because everybody’s buying every dip now.”
Yes, the rally is on, and hopes are high. Looking deeper into the rally reveals the even more good news. Historically, smaller companies outperform their larger counterparts during initial periods of economic growth. Also, smaller companies perform particularly well during times of high growth with declining corporate tax rates as President-Elect Trump has promised. Currently, the US has the highest top tax rate on corporate income of all industrial nations at 38.9%. A distant second behind the U.S. are France and Belgium at 34.4%.
Investors are bullish on the US and the stock market and particularly bullish on the prospect of exceptional growth among the small corporate sector. Below is a chart of the three indices, S&P 500 (large companies), S&P 400 (mid-sized companies), and S&P 600 (small-sized companies). At the beginning of the year, all three sold off hard and especially small and mid-indices. During the year and despite dire outlooks for the economy and stock market, the small and mid indices slowly outperformed the large cap index. However, after the election, the small and mid indices shot up with the S&P 600 jumping almost 19% in three weeks.
The outperformance of the S&P 600 and S&P 400 is encouraging news for the potential of true sustainable economic growth. As mentioned in this space, small companies are the drivers of economic growth and create more jobs than all large companies combined. Smaller organizations are more receptive to paying hirer wages as their ability to adapt to market changes produces more revenue opportunities. A healthy and vibrant economy is one with a robust calendar of Initial Public Offerings (IPO’s) by small to mid-sized companies developing disruptive societal innovations. The trend for the past eight years were mega-mergers and consolidations of the largest companies with many quarters of few to no IPOs of smaller companies.
While a focus on passing business-friendly legislation while repealing many of the most crippling laws will favor small and mid-sized companies, the rally in the dollar may challenge profits on exports and those companies with a high percentage of revenue from international sales. Larger companies already have corporate centers throughout the world trading in the country’s markets so rising, and falling currencies are not as problematic. Unfavorable currency exchange rates will detrimentally impact smaller companies with only a few distribution centers around the world or most of their product sold from the US. A rising dollar reduces the profit potential as US based products are purchased with non-dollar currencies that have been declining in value to the dollar.
WHAT DOES THIS MEAN TO ME?
We are optimistic on the recent rally continuing into a sustainable trend. Admittedly, the rally surprised many institutional investors who only three weeks ago, were projecting declining growth and the fear of dis-inflation (decline of prices). Those concerns have evidently vanished and have now been replaced with prospects of hyper-growth and inflation. If the rally continues then, the big winners will be in the small and mid-sized corporate sector. Typically, one would expect investors that have endured two years of a stagnant economy and now embracing the prospects of new growth to first increase their investments in stocks of larger companies. Then as evidence of economic growth is developing they would move their focus to smaller companies with higher risk. Not so with this rally, institutional investors immediately focused their investments in smaller corporations. Such action is an indication of how the most informed managers are viewing the potential next few years. We would suggest following the lead of the institutional managers and consider increasing your allocation to small and mid-sized company sector.
As you can see, there are many indicators for our consideration and even more that we did not discuss during this update. Do you agree that Trump policies will produce sustainable economic growth? Do you believe his policies will be good for America long term? Let us know as we value your opinion.