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The numbers are a bit small there, but the total return of the Russell 2000 small cap index is a shocking -0.24% over the last 3 years. Ouch. That’s with the broad market UP 30% in the same time frame. Double ouch. But there’s a lot of reason to be optimistic about small caps if you ask me… For one thing, like we just stated, they’ve lagged for a long time. Now, I don’t believe in “due” when it comes to the markets. Just because something is overdue in moving up, doesn’t mean it will… But I do think cycles are real, and we could be entering a small cap cycle by this time next week. Interest rates are coming down. That’s typically a big boon to small caps because they are usually less cash rich than mega cap companies and rely on loans. When interest rates are high, it eats up their profits or explodes their debt. And we also have a higher percentage of a Republican coming into office than we’ve seen since the Trump vs Biden debate. Now, politics aside, we expect a Republican administration to pull back regulations and create a better tax atmosphere for small businesses. Ironically, a lot of folks believe the Republican Party is the party of the ultra-wealthy. Now, whether you are on the left, right or simply don’t care… That's not the point. This is an important thing to understand for the markets. You see, in reality, most ultra-wealthy corporations favor Democratic leadership dramatically. In fact, even in 2016 and 2020, as Democrats ran on the classic “Make the wealthy pay their fair share” platform, they piled up the vast majority of wealth: To be fair, the individuals who run those companies are likely split more down the middle, but if you were to survey the top 100 corporations in the US on their business culture, you’d end up with staggeringly left-leaning results. But why? Well, the answer is simple: A more regulated, higher tax environment (like we see more commonly in Democrat legislation) benefits the elite. It makes it much harder for smaller companies to get market share, navigate shifting regulatory environments, get access to capital, and compete with large companies where the elites have much of their wealth parked. So if you’re Apple, it makes total sense to prefer Democratic leadership. Ideally, you exist in an environment where it’s a bit harder to overcome hurdles to challenge your dominance, right? Companies that don’t have the market share and cash on hand to deal with regulatory updates or tax complications will have a tougher time. And I think the QQQ (heavily weighted to the biggest companies on the planet) outperforming small caps by such a massive level since 2008 with 12 out of 16 years having Democratic leadership is a good example of this at play: And, again, this shouldn’t really surprise us… Let’s say a startup tech company wanted to compete with Amazon’s cloud computing (AWS) offerings… They’d need data centers, which require access to large sums of capital, which is hard to get in a high interest rate and inflationary environment. They’d need to navigate a plethora of privacy laws, regulations, and the FTC just to get up and rolling. Now, of course, I am over-simplifying it to make a point, but hopefully you can see the practical elements of how this market is unfolding. I mean, let’s be blunt… Government officials (on both sides) sit around all day, brainstorming new regulations in their attempt to help the US (maybe they are targeting climate issues, maybe they want to go after bad business practices, maybe worker’s health, etc.). Of those rules, thousands of pieces of legislation are aimed at businesses. And businesses are forced to comply with these new rules and regulations on a constant basis. Now here’s the reality: most of our politicians aren’t successful business professionals (again, on both sides). I know this might shock you, but they often pass regulations without really understanding how they are going to impact the businesses they’re attempting to govern. Ultimately, a very high percentage of legislation is harmful to the businesses they’re imposed on. So think about it like this: Which companies are best equipped to handle harmful regulations? It’s undoubtedly the largest and most profitable companies on earth. So why do I think small caps could be getting their chance? As I showed you in the chart above, for the longest time we've seen small caps lagging behind large caps at a historical rate. But the world could look very different very soon. Interest rates have started coming down, and inflation has tamed somewhat despite the higher price environment we are all now living in. With lower interest rates, smaller companies can get access to capital, investment, and loans much easier. That means growth for these small-cap companies. And if Trump were to win, it could be a big boost to the already obvious potential here in small caps. Now, don’t get me wrong… I am still ALL IN on the biggest and best businesses out there. The ones leading are more likely to keep leading than any others as far as I am concerned. But I am also looking for opportunities on Small Caps because the potential is so significant. We could see a 10 year cycle in small caps with incredible upside. Remember — historically, small caps produce larger net gains than large caps and, right now, they are lagging far behind. So there is a ton of room for them to catch up and it could be a moonshot opportunity if things play out the way they look right now. And, we don’t need Trump to win for that to happen… but I believe it would be a clear catalyst if that’s what happens. So, for another week or so, we’ll be in “wait and see” mode for that particular trigger. In the meantime, I am loving these Overnight Options. Just a few pennies from another win today :) If you’re not in, what are you waiting for? Check out the Overnight Income Project here — Nate Tucci |
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