Over the weekend, President Trump announced his plans to increase tariffs on $200 billion dollars of goods from China and new tariffs on $325 billion of imports that were previously untaxed.
Under the proposed escalation, both sets of tariffs would be taxed at a new rate of 25%. The news came as a surprise as investors had been largely expecting that the two countries were closing in on a trade deal. As the markets have rushed to assess both the likelihood of the potential escalation and its impact, we’ve seen big swings in the equity markets.
Although a full breakdown in trade negotiations seems unlikely despite increased pressure by the U.S., it’s worth reviewing the benefit of having exposure to small cap stocks when considering the impact of tariffs. Smaller companies tend to be more domestically focused than large multinational corporations who may have significant parts of their supply chains, customers, and operations abroad. Although the additional taxes will have ripple effects throughout the economy, larger companies are much more likely to face a greater impact to their bottom line because of their global scope. For example, S&P 500 index firms generate 38% of their earnings from overseas while S&P SmallCap 600 firms derive just 20% according to FactSet[1].
As the markets processed the tariff news, large U.S. companies as measured by the S&P 500 were down 2.1% through Tuesday and smaller companies (represented by the Russell 2000) declined 1.9%. A similar story unfolded last year as the markets reacted to tariff announcements from March to June of 2018 where the Russell 2000 outperformed the S&P 500 by over 8%. By having exposure to the entire US stock market, your portfolio will be positioned to take advantage of any out performance smaller companies have over their larger counterparts during times of escalating trade tensions.
[1] https://www.gurufocus.com/news/731627/small-caps-continue-to-surge