Small-cap outperformance likely to continue into the US election: Wells Fargo

Investing.com -- Wells Fargo analysts believe small-cap stocks are positioned for further gains leading into the U.S. election, driven by strong economic signals and potential GDP revisions.

“We continue to like small caps and expect them to outperform heading into the election,” the bank states, citing Q3 GDP as a critical catalyst.

The analysts highlight that month-to-date, small caps (measured by the Russell 2000 ) have already gained 2.6%, surpassing the S&P 500’s 1.4% increase.

They expect this trend to continue, regardless of the election outcome. “We were set to unwind this trade with a Harris win (and maintain it with a Trump win). But if we are right about economic strength and potential GDP revisions, we would not unwind the trade under either political outcome,” the note reads.

Wells Fargo also points to upcoming GDP data as a significant factor. The Atlanta Fed’s forecast for Q3 GDP is 3.2%, much higher than the consensus estimate of 2.1%.

“In the last 12 quarters, the Fed’s forecast exceeded consensus by 0.4%+ seven times; all 7x the GDP print beat consensus. Small caps outperformed by ~2% on the strong 2Q24 GDP report,” the analysts explain, suggesting that positive GDP surprises tend to favor small-cap stocks.

Looking beyond the election, Wells Fargo anticipates renewed economic activity as political uncertainties subside.

“We expect economic activity to tick up post-election as political uncertainties fade and pent-up demand is realized,” the analysts note.

The report also references responses from ISM Manufacturing surveys, indicating that many companies have postponed purchases until after the election but are likely to resume spending afterward.

Wells Fargo says that during previous periods of economic optimism, such as 1Q24, the Russell 2000 rallied 9.4%, outperforming the S&P 500 by nearly 1%. Wells Fargo believes a similar “reflation trade” could be on the horizon, giving small caps another boost.

Source: Investing.com