Since the first reports of a possible Republican victory across the White House and Congress, the S&P 500, Nasdaq and Dow Jones indices all gained, with the small-cap Russell 2000 closing nearly 6% higher on November 5.
The very same day, the US dollar index hit its highest point since July, rallying against other global currencies, while the euro fell on expectations of increased tariffs on European goods. also rallied, soaring from USD 68,000 to USD 99,000 between election day and November 22.
Trump Wins, Market Reacts
Investors, therefore, reacted very quickly to the election result of the world’s largest economy, including here in Europe. One of the best ways to analyze their asset allocation choices is to follow the exchange-traded funds market, which are vehicles that by their nature are easily and quickly tradable, and also suitable for short-term tactical positions.
We analyzed the weekly flows of some categories of ETFs – the ones most exposed to the US election outcome – over a four-week period, starting right from the week of the election.
In a nutshell, European investors reacted to Trump’s victory by buying US equity ETFs, both large-cap and small-cap, and global equity strategies where US stocks carry a predominant weight. At the same time, they sold precious metals exchange-traded commodities--most of them exposed to gold-- emerging markets equities, and thematic strategies on clean energy.
More intricate, meanwhile, is the picture concerning US-China relations and the outlook for the Chinese stock market.
ETF Investors Are Betting on US Small- and Mid-Caps
Absolute numbers are important, but to understand more deeply the strength with which assets have moved, the most useful metric to use is the organic growth rate. For any given period, organic growth rate is defined as the cumulative flow for the period divided by the beginning total net assets.
In this respect, the categories that have most benefited from Trump’s election have been US small-caps and US mid-caps. To provide perspective, in the first two weeks after the election, US small cap equity ETFs have attracted around EUR 2.17 billion of net inflows, when the category’s best monthly result on record (July 2024) saw EUR 1.11 billion taken in.
The Morningstar US Small Cap Index returned 11.6% since the election, while large-company stocks – which have been leading the two-year bull market – gained 8.1% (in euros, as of November 26). Strategists credit the outperformance of small-company stocks to investor enthusiasm about their prospects under new Republican policies, coupled with relief that uncertainty surrounding the election was finally at an end.
Are Small Caps Worth the Risk?
Small caps are risky, but under the right circumstances, they can boost returns and improve diversification of a broader portfolio.
Part of the appeal of small caps is that some will go on to become mid- and large-cap stocks; the risk is that most of them won’t. Small-cap investors benefit from a firm’s growth as their business improves and expands. And by investing in a portfolio of these businesses, such as through a small-cap ETF, risk and opportunity is spread across hundreds or even thousands of stocks.
Small companies are risky in part because they don’t usually possess the same competitive advantages as larger firms. Only 2% of companies in the small-cap index boast a wide Morningstar Economic Moat Rating, compared with 76% of firms in the large-cap index. At the same time, though, small caps should have an edge during bull markets, and they are also more sensitive to interest rates, which can fuel further growth in low-rate environments.
Morningstar’s Chief US Strategist Dave Sekera stated in his regular quarterly analysis and outlook appointment that small cap valuations remain far below the US market average and may present an opportunity for ETF investors willing to take the risk.
The author or authors do own shares in any securities mentioned in this article. Find out about Morningstar's editorial policies.
