By Louis Krauskopf
NEW YORK (Reuters) – As investors seek assets that will shine under a Donald Trump presidency, a corner of the U.S. stock market expected to benefit from Republican policies is faltering.
Smaller US company stocks have come under pressure, with the small-cap Russell 2000 index last week seeing a 10% correction from its November highs. The Standard & Poor’s 500, the benchmark index for large-cap companies, fell less than 3% at the time.
Trump, who will be inaugurated for his second term on Monday, is expected to support an agenda to boost domestic economic growth, increasing the appeal of penny stocks.
But the group has faced a severe headwind in recent weeks: the possibility of interest rates being higher than previously expected, which would push up borrowing costs that have hit small businesses particularly hard.
“With more pro-growth policies, small companies tend to do better in theory when the economy is stronger,” said Keith Lerner, co-chief investment officer at Truist Advisory Services.
“You almost have this tug of war,” Lerner said. “On the one hand, stronger growth should be good for small businesses. On the other hand, higher interest rates are negative.”
Small companies and stocks broadly got some relief this week from an encouraging inflation report that cooled the rise in Treasury yields.
The focus on penny stocks comes as investors look for “Trump trades” that have room to run.
The overall stock market has given up some gains since Trump’s Nov. 5 victory, when investors were enthusiastic about his pro-growth agenda that broadly benefited stocks. The S&P 500 is up 3% since the election.
Some of Trump’s deals continue to flourish. Shares of Tesla, led by Trump supporter Elon Musk, have risen more than 60% since November 5. Bitcoin, which is expected to benefit from a friendlier regulatory environment for cryptocurrencies, rose more than 40%.
But small businesses pulled out. The Russell 2000 rose nearly 6% the day after Trump’s win. Later in November, it reached its highest closing level in three years. Now the index has not changed much since the election.
Expectations of smaller interest rate cuts this year have dampened small business sentiment, with the Fed in December forecasting less easing as it raised its inflation estimates in 2025.
Treasury yields rose. This week, the benchmark 10-year yield reached a 14-month high.
Young-Yu Ma, chairman of the board, said small companies “tend to have larger debt burdens…so not continuing low interest rates is like pouring a little cold water” on hopes for small-cap strength. Investment Officer at BMO Wealth Management.
The Russell 2000 rose after Trump’s election in 2016 and the index continued to outperform the S&P 500 in the year following his first victory, rising 24% versus 21% for the large-cap index.
Samir Samana, chief global market strategist at the Wells Fargo Investment Institute, said that under Trump, the prospect of reduced regulation and a boost in domestic business should benefit small companies, whose businesses tend to be more U.S.-focused than larger, multinational companies.
But while the group’s outlook has improved under Trump compared to his predecessor Joe Biden, the next president’s preference for tariffs could cause problems for small businesses if they disrupt supply chains, Samana said.
“There will be some good things under the Trump administration… but there will also be some negatives,” Samana said.
Small-cap bulls have some catching up to do. The S&P 500’s roughly 50% gain over the past two years is more than double the rise of the Russell 2000.
However, small businesses may face headwinds if interest rates continue to rise. Small-cap indices tend to be more weighted toward financials and industrials, sectors that are relatively more sensitive to rising interest rates and inflation, according to Truist’s Lerner.
The Russell 2000 retained a 37% weight in these two sectors as of the end of 2024, compared with about 22% for those groups in the large-cap S&P 500 index.
Trump’s arrival represents an opportunity for small businesses, “but the thesis for outperformance probably depends more on a favorable interest rate environment,” BMO’s Ma said.
(Reporting by Louis Krauskopf; Editing by David Gregorio)