Why Trump’s Victory Is Boosting Small-Cap Stocks
Wednesday was a historic day for the stock market. The S&P 500, Nasdaq 100, and Dow Jones Industrial Average reached all-time highs during Wednesday’s post-election session, as markets attempted to gauge the incoming Trump Administration.
But the star of Wednesday’s show was the only major U.S. stock index that didn’t reach new heights. The Russell 2000 soared 5.84%, far more than the above indexes. Why is the small-cap index rallying right after the election?
The Russell 2000 broke out of an ascending triangle pattern (black dotted lines) in a convincing manner, leading us to believe this move could have legs. The index has remained above its 50-day moving average for nearly all of the past two months (blue line), and has stayed above its 200-day moving average (red) since the start of this year.
Russell 2000 chart via Tradingview
Despite Wednesday’s performance, the Russell 2000 has gained just 18.9% year-to-date. Over that time, the S&P 500 and the Nasdaq 100 have both gained 25%.
Why is the Russell 2000, which has underperformed the other major indexes, suddenly thrust into the spotlight? To understand, let's look at a chart of the U.S. Dollar Index.
As the election approached, the dollar formed a cup-and-handle pattern (shaded yellow). When the results were in, the dollar broke out of that pattern. On Wednesday, the dollar traded at its highest level since mid-July.
U.S. Dollar Index via Tradingview
If the greenback's post-election rise seems familiar, you're not alone. This is similar to what happened when Trump won in 2016, as demonstrated in the chart below (green arrow).
U.S. Dollar Index via Tradingview
What does any of this have to do with the small-cap stocks that populate the Russell 2000?
Think about the components of the S&P 500, the Nasdaq 100, and the Dow 30. Many of these companies are behemoths. On the S&P 500, there are now seven companies that are worth over $1 trillion each, and three companies worth over $3 trillion apiece.
Huge multinationals conduct business nearly everywhere in the world. Some conduct more business outside the U.S. than within it.
As the dollar gains strength, companies that derive a large portion of their revenue from outside the U.S. begin to lose money on currency exchange rates. As the buck rises, profits that are earned in foreign currencies translate poorly when that money is calculated in dollars. Some companies may even miss earnings due to dollar strength.
Conversely, the smaller companies that comprise the Russell 2000 tend to do a larger percentage of their business in the U.S. Therefore, these small-cap companies are less likely to be affected by dollar strength than their larger counterparts.
How long will this dollar rally continue?
In 2016, the rally started around the time of the election — and ended about when Trump was sworn in. If the same holds true this year, the Russell 2000 could finish 2024 strong, with a solid start to the New Year.
At the time of publication, Ponsi had no positions in any securities mentioned.