Investing.com -- A Trump victory could drive hedge fund investors toward small caps, which have recently been tracking Trump’s betting odds in October, RBC Capital Markets said in a report.
This trade has historical precedent, as small cap positioning surged in 2016, 2017, and 2018 amid optimism following Trump’s win, corporate tax cuts favoring smaller companies, and the US-China trade war.
Small cap futures surged higher on Tuesday night as election results rolled in, with the Russell 2000 index gaining 5.8% by Wednesday.
Strategists at RBC noted one of the key investor questions on Wednesday was how much more room small caps might have to climb.
They suggested that positioning and sentiment might already be somewhat stretched, with Russell 2000 futures close to highs seen in 2016, 2017, and 2018, according to the latest CFTC data.
The strategists recommended monitoring the Russell 2000's median price-to-earnings (P/E) ratio, which was at 16.7x as of Tuesday, compared to previous peaks of 18.9x in 2016, 19.7x in 2017, and 17.6x in 2018. This suggests some limited potential for further gains.
“There’s not a ton of room left, but likely some even after Wednesday’s big move,” strategists wrote.
Looking back, RBC observed that small caps outperformed large caps for a period following both Trump’s 2016 win and Biden’s 2020 victory, though both rallies were relatively brief.
The 2016 outperformance peaked about a month post-election, followed by two shorter rallies in 2017 and 2018. In contrast, the 2020 rally lasted about four months.
Intriguingly, both periods of small cap strength were accompanied by rising 10-year Treasury yields.
Trump is set to return to the White House for another four-year term, alongside his vice-presidential pick, Senator JD (NASDAQ:JD) Vance of Ohio.
NBC News projects that Republicans are likely to reclaim majority control of the US Senate in 2025, with at least 51 seats secured in the 100-member chamber by January, when the new Congress is sworn in.