U.S. stocks are experiencing a resurgence of volatility as investors grapple with the prospect of a potential trade war and its threat to economic growth. However, one part of the market is seen as fairly immune from this pressure: small-capitalization stocks.
The stocks of small companies are seen as having a higher exposure to the U.S. in terms of revenue, which could insulate them from an international dispute. For this reason, small-caps, as measured by the Russell 2000 index RUT, -0.46% are also seen as an alternative in periods of U.S. dollar strength, which can erode the profits of large multinational companies.
Concerns about trade policy have spiked recently, after the Trump administration announced new trade restraints against China. This comes on the back of President Trump imposing tariffs on aluminum and steel imports earlier this month.
“Small caps, which began outperforming in late February, continue to do so given less exposure to trade wars thanks to more domestic sales than large caps,” wrote Alec Young, managing director of global markets research at FTSE Russell.
He added that the Russell 2000 index of small-capitalization stocks had a lower exposure to the technology sector. While this has limited the Russell’s advance over the past year, a period where tech was the top-performing sector, it has provided some insulation from recent turbulence in the sector, given a sharp decline led by Facebook Inc. FB, -1.46%
Whereas 69.7% of the S&P 500’s revenue exposure comes from the U.S., according to FactSet data, it is 79.4% for the Russell 2000. The Dow has the least U.S. revenue exposure, at 61.7%.
The level of U.S. exposure roughly correlate with how well the indexes have held up thus far this month. The Dow DJIA, -1.13% is down 2.4% from its Feb. 28 close (the trading day before the Trump’s tariff announcement), while the S&P SPX, -1.04% has lost 1.1% since then. The Nasdaq Composite Index COMP, -1.05% is flat over that period, but the Russell has easily eclipsed all of them: it is up 4% over the period.
Thomas Lee, a managing partner at Fundstrat Global Advisors, cited a similar strategy in a recent research note. “While we do not have a specific insight whether a trade war is realized, we have assembled a group of industries which have low exposure to a trade war,” he wrote. First on the list: companies with low exports as a percent of sales.