Why Small-Caps “Trumped” Large-Caps Last Week

November 16, 2016 | Nat Kellogg, CFA, President

The election of Donald Trump last week caught the market by surprise and created a significant amount of volatility and dispersion across the U.S. equity market. One area of note was the huge outperformance of small-caps (up 7.7% from November 8–11) vs. large-caps (up 1.2% November 8–11). The Republicans made it a clean sweep Tuesday night, winning the White House and maintaining control of the House of Representatives and the Senate. While there is a lot of policy uncertainty as a result of this election, the market now believes there is a high likelihood of corporate tax reform being passed some time in 2017. Donald Trump’s plan calls for a reduction of the corporate rate from the current level of 35% (one of the highest rates in the world) to just 15%. Paul Ryan previously put forward a plan for corporate tax reform that would lower the rate to 20%.

While a cut in corporate taxes is likely to benefit all companies, our chart of the week shows that small-cap companies pay a much higher effective rate (i.e., the rate they actually pay after deductions and credits) than their large-cap peers. This is primarily because large multi-national companies generate a significant portion of their earnings in lower tax countries, while small-cap companies tend to be domestically focused, and thus pay very close to the U.S. statutory rate.

If the corporate tax rate is cut to 20%, this will result in a much larger increase in earnings for small-cap companies compared to large-cap firms (shown by the green dots on the graph). Optimism that this increase in earnings from a tax cut will materialize at some point next year is one of the key factors that drove the outperformance of small-caps last week.

Nat Kellogg, CFA
President

Get to Know Nat

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

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