Small US stocks lag multinationals

Posted January 16, 2019 1:02 p.m. EST

— Smaller US-based companies that do most of their business in America were supposed to hold up better than the giants of the Dow and S&P 500 at a time when there are concerns about a shaky global economy and US trade tension with China.

But the Russell 2000, an index that focuses on small US stocks, has fallen nearly 15% since the start of last October while the Dow and S&P 500 are each down about 10% over the past few months.

That's despite the fact that multinationals in the Dow and S&P 500 like Apple (AAPL), Intel (INTC), Boeing (BA) and Nike (NKE) have significant exposure to China and Europe.

What gives?

Chris Gaffney, president of world markets at TIAA Bank, said investors jumped to the wrong conclusion about how smaller US companies would fare in light of weaker demand from China and other international markets.

"Small stocks may not be protected from trade war after all. Even though many of them may not export products to China, they make supplies to companies that do," he said.

This whole notion that the United States can go it alone is a myth in the 21st century hyper-connected global economy.

"In a globalized world, there is no isolation," said Raoul Pal, founder of the Global Macro Investor advisory firm and CEO of financial media site Real Vision.

Pal noted that heavy debt loads for big US companies like General Electric (GE), GM (GM) and Ford (F) won't help smaller companies that need to borrow money for expansion.

As more US giants get downgraded by the credit ratings agencies, it will be tougher for small firms to get loans.

"The weakening of the corporate bond market will be a problem for everyone," Pal said. "It could freeze credit for smaller companies."

The recent pullback in the value of the US dollar isn't helping either. Smaller US companies benefit when the dollar is stronger since it makes imported goods more expensive than those made in America.

But the US Dollar Index, which tracks the value of the greenback against the euro, yen and other major currencies, has fallen 1.5% since mid-November.

Many expect the dollar to weaken further as well since there are growing hopes that the Federal Reserve may stop raising interest rates. A series of rate hikes last year helped boost the dollar in the first place.

There's also the simple fact that smaller US stocks are riskier than big household names.

James Ragan, director of wealth management research with D.A. Davidson, said one reason why the Russell 2000 has underperformed the broader market lately is that they are far more expensive.

According to data from Birinyi Associates, the Russell 2000 is trading at nearly 21 times earnings estimates for the next 12 months, compared to just 15 times the estimates for the Dow and S&P 500.

Ragan noted that smaller companies may not be the best place to hide with fears of slowing economic growth rising.

So it's only natural for investors to dump smaller stocks that have more room to fall if there is a prolonged downturn.