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Trade uncertainty darkens US small caps outlook

“Because they have more domestic sales it doesn’t mean they’re totally insulated,” said Jill Carey Hall, US strategist at Bank of America Merrill Lynch. “If we don’t get a resolution on trade, you don’t necessarily want to own small caps. They tend to fare more poorly in risk-off environments.”

Since US President Donald Trump’s May 5 tweets about raising tariffs on $200 billion of Chinese goods to 25 percent from 10 percent the S&P 600 has fallen 5,4 percent and the Russell 2000 small cap index has declined 4,9 percent compared with the benchmark S&P 500’s 2,9 percent drop.

One problem is that companies depending on imports for inventory had no time to stock up in the days between Trump’s tweet and the actual tariff hike, started May 10.

And if the United States fulfils its threat to slap 25 percent tariffs on another $300 billion of goods that China sells here, that would add to the pressure.

Wall Street is already expecting a first-half earnings recession for the S&P 600 index of small cap stocks. The average expectation is for a first-quarter earnings per share decline of 18 percent followed by a 9 percent second-quarter decline, according to I/B/E/S data collected by Refinitiv analyst David Aurelio.

“This will be the worst reporting season for small caps since 2009,” said Jefferies equity strategist Steven DeSanctis, referring to first-quarter results.

Looking forward, analysts expect third-quarter EPS growth of 6,9 percent for the S&P 600 and 23,3 percent growth for the fourth quarter, according to Refinitiv’s Aurelio.

But Wall Street may be too optimistic about the second half of the year, especially if the US-China trade dispute is not resolved, according to DeSanctis, whose firm is predicting a prolonged trade battle.

“For small caps to pick up and resume their out performance we need to see better trends in the economic data in the second half, which would lead to better earnings growth in the third and fourth quarter, which the Street is expecting,” he said.

In fact, traders in the bond market and fed funds futures are making bets that imply the exact opposite — that US economic growth will weaken. — Reuters.

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