Wall Road Week Forward: Small caps are a part of the market rally, however a pandemic might derail them

© Reuters. FILE PHOTO: People in face masks walk in front of the New York Stock Exchange in New York

By David Randall

NEW YORK (Reuters) – US small caps took part in the broad market rally in the days following election day as investors judged the likelihood of Washington being divided, with Democrat President Joe Biden and Republicans retaining their Senate majority.

However, some investors and analysts warned that smaller businesses could run out of steam as the coronavirus pandemic shows no signs of slowing. Most importantly, if Senate Republicans block his efforts there, small caps will bear the brunt of any aggressive measures Biden could take to fight the pandemic without benefiting from a big stimulus package.

Democrats could still take over the Senate if Georgia's two contested seats go into a runoff election in January, as is now expected. This could lead some investors to price back the ability to issue bills that will benefit small caps.

However, smaller businesses are likely to continue to bear the brunt of the pandemic, which is reaching record levels in the US.

"A more aggressive reaction from President Biden could put small caps at risk," said Sylvia Jablonski, director of Direxion.

"The best scenario for small caps is a full reopening of the economy with manageable Covid levels before a vaccine comes out and some form of stimulus with a supportive Fed. Worst case scenario is a lot less stimulus than we'd hope for a full shutdown had or something close by, "she said.

These concerns are reflected in the underperformance of small caps since election day. The small-cap stocks index is up 2.6% since Nov. 3, a little more than half the 4.2% increase in the large-cap S&P 500 index over the same period. The underperformance mirrors that of the past five years, where the Russell is up 38.2% compared to a 67% jump in the S&P 500.

U.S. coronavirus cases rose by more than 120,000 on Thursday, according to a Reuters tally. This is the second record increase in a row per day as the virus spreads to all regions of the country. Twenty of the 50 states reported record increases on Thursday.

The increasing number of cases in Europe has resulted in economic lockdowns and other restrictions being re-established there. France, Germany, Italy and the Netherlands have announced new restrictions, while UK lawmakers voted for a month-long lockdown.

"The impact of the ongoing second wave of COVID-19 in Europe and the third wave in the US remains uncertain, and the results of the vaccine trials through the end of this month remain an important catalyst," analysts said Barclays (LON 🙂 wrote in a note on Thursday advising investors to continue to hedge against a sharp decline in US small caps.

Small caps could remain volatile for the week ahead as Congress resumes negotiations on a stimulus package. Senate Majority Leader Mitch McConnell has refused to pass a House Democrat-backed $ 2.2 trillion bill by the end of the year. "

The advancement of economic talks and the number of coronavirus cases are likely to determine the path of small-cap stocks in the coming weeks, as Biden won't take office for another two months, said Esty Dwek, head of global market strategy at Natixis Investment Managers.

Biden will not want to "spend political capital to lock down the country or get people to follow a national mask mandate that would be extremely difficult to implement," she said, making the risk of widespread economic lockdown "minimal". .

Small caps could outperform again in 2021 as new cases decline and vaccines and other treatments become available, she said.

"We will think about this reopening again and move past the virus," she said.