It’s no secret that large cap stocks have traded well in the six months since the election, riding hopes of sweeping corporate tax reform by the new administration. Microcaps have closed the gap in recent months, however, as uncertainty continues to linger over what the full extent of such tax reform will ultimately be.

We’ve stated previously that microcaps would benefit from the rotation out of large caps as the administration’s proposals and objectives continued to be poorly articulated and without a realistic possibility of garnering Congressional approval, and we believe the tape bears out our thesis. It may be instructive to look at how the two ends of the spectrum have traded over the past year, 6 months and 3 months.

Over the past 12 months, microcap stocks have outperformed large caps by over 5%. Using the ETF proxies, the iShares Micro-Cap ETF (NYSE:
IWC)
has returned 20.3% over the past year, while the bellweather SPDR S&P 500 ETF (NYSE:
SPY)
is up 15.2%.

IWC vs SPY, 12-months

Looking at the period since November 2016, we see that large caps outperformed microcaps by nearly 7%, fueled by hopes that the administration would enact numerous tax and regulatory reforms that would benefit the largest companies in the country. As history shows us, however, hope is a poor substitute for a strategy.

IWC vs SPY – 6 months

The market’s sentiment has clearly shifted with regard to how successful the administration will be in driving its agenda through Congress, particularly as it relates to meaningful corporate tax reform. In the most recent 3-month period, the performance gap between large caps and microcaps has shrunk to about 1.6%. The longer we go without seeing a workable tax plan that’s acceptable to both sides of the aisle, the greater the uncertainty will be at the large cap end.

IWC vs SPY – 3 months

While the Russian investigation has been making copywriters’ jobs easy, we think the market is much more concerned with how long it will be before we see a meaningful, financially viable tax plan from the administration that isn’t the reverse Robin Hood that many perceive. We fully expect to see the large cap performance gap disappear and to see microcaps overtake large caps as the days continue to get longer and we continue to see no progress on tax reform.

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