What it Will Take to Get Small Caps Out of the Bullpen Again

After the election, small cap stocks rallied the most — and for good reason. They are a pure play on American growth as most small caps have limited, if any, exposure to international sales.

Plus, they’re the companies that would benefit the most from infrastructure improvements (which boost revenue), tax reforms (which increase profitability), and lower regulation (which lowers expenses).

So why on earth … based on this relative chart of the Russell 2000 Index (small caps) vs. the S&P 500 (large caps) … has their performance fallen off by so much? In this graphic, the stronger (higher) the line, the stronger the relative performance of small caps:

I think the answer is simple: With the Federal Reserve out of the stimulus business, we need our elected members in government to step up to the plate!

We’ve clearly had a few stumbling blocks on that front. Repeal and Replace 1.0 failed, for instance, and we didn’t get anything concrete on infrastructure in the first few months of 2017. The market expected a majority-Republican Congress and Executive branch to be able to easily get things done, and that didn’t happen.

As a result, the small cap rally faded, and the previous, pre-election trade emerged. So-called “FAANG” stocks (Facebook, Amazon, Alphabet, Netflix, Google) once again took the lead.

But Repeal 2.0 did just clear at least one major hurdle. The sooner that it can get done, the better in my opinion. Once we can finally get healthcare reform out of the way, we can focus on the next big market rally-inducing policies – tax reform and infrastructure.  That will lead to small caps getting their call in the bullpen … and taking the lead again.

One stock that could thrive, but that succumbed to the lack of clarity from policy makers, is AK Steel (AKS, Rated “C-”).

It has fallen consistently since December as policy hopes faded. But as soon as we get to infrastructure, or mentions of it in Washington, this stock will be on fire. It’s too cheap to ignore and is just waiting for its call to come out of the bullpen.

So keep watching for clues from policy makers on what comes next after we get through healthcare. I know I will be.

Best,

Mandeep

Mandeep Rai has more than 15 years of investing experience, working as both a stock and credit analyst. At Weiss Ratings, he researches and evaluates financial and economic themes, and makes decisions on when to buy or sell specific shares for the Top Stocks Under $10 portfolio.