“I say there is 20 percent more cash to come to these companies in the next 24 months through tax reform, so I am staying on this trade. I am betting they continue to outperform not only the S&P, but maybe even emerging markets. There is tremendous value to be unlocked in small caps in America,” O’Leary said on CNBC’s “Power Lunch.”
Small caps, or companies with a relatively small market capitalization, like those on the Russell 2000, have been racing ahead of large caps since February. They are normally considered the riskiest group in the U.S. stock market, due to high volatility, but investors have increasingly turned to these stocks as insulation against the trade wars. Since about 80 percent of small-cap revenues are domestic, they experience far less direct impact from tariffs or other trade retaliation than large caps.
News of PresidentDonald Trump’s progress with Mexico on trade talks could prompt investors to once again broaden their focus to international stocks, but O’Leary maintained small caps are a safe play, thanks to deregulation from tax reform.
“For the next two years, the full impact of tax reform will play out in enhanced cash flows in small caps, because what we have seen now is primarily driven by deregulation …. That’s why you are starting to see this momentum,” O’Leary said.
Brinker Capital global investment strategist Tim Holland acknowledged declining trade tensions “may take some of the bloom out of the small-cap rose,” but he also said small caps have numerous other tailwinds to fuel their growth.
“If you look at the structural tailwinds for small caps right now — the tax cut, the deregulatory environment, incremental buybacks here at home — we still think small caps, in the end … are still the most attractive as we go into the end of 2018,” Holland said Monday on CNBC’s “Power Lunch.”
Despite his optimism, Holland warned the markets as a whole — small caps included — may experience a pullback in the coming months due to seasonal weakness in the equity markets, Federal Reserve rate hikes and special counsel Robert Mueller’s investigation.
“We wouldn’t be surprised to see a bit of a pullback into the fall — the calendar tells you that’s probably going to happen,” Holland said. “But if you step back and think about fiscal policy, earnings, hopefully improving trade rhetoric … at Brinker Capital, we’ve been overweight risk assets, overweight U.S. equities, and we think that positioning continues to make sense.”
The Russell 2000, which tracks the bottom 2,000 stocks on the Russell 3000, is up 12.55 percent year to date. The S&P 500 is up only 8.35 percent since then, according to FactSet.