Now it's time for a near-term small-cap trade: Wells Fargo

Investing.com -- Current market conditions present a compelling opportunity for a near-term small-cap trade, Wells Fargo analysts said Monday.

According to the investment bank, a combination of a close U.S. presidential race and favorable economic catalysts makes small-cap stocks particularly attractive in the short term.

Wells Fargo points to a "50/50" presidential race that creates significantly skewed returns for small caps, particularly in the event of a Trump victory.

“Small caps have a positive expected near-term relative return as the Presidential race is essentially a coin toss (per RCP) with five weeks to go,” analysts wrote.

“In our view, expected small-cap returns are favorably skewed, with significant near-term outperformance with a Trump win and limited underperformance with a Harris victory,” they added.

Based on market behavior following the 2016 election and the attempted assassination of Trump in July 2024, Wells Fargo anticipates a 5-10% outperformance by small caps within 1-3 months if Trump secures a victory.

After the 2016 election, the S&P 600 Small Cap surged 15.7% by year-end, compared to a 5% rise in the S&P 500 . Similarly, in the wake of the July 2024 assassination attempt, the S&P 600 gained 6.4% by the end of the month, while the S&P 500 declined by 1.6%.

Even in a scenario where Vice President Harris wins the presidency, Wells Fargo believes the downside for small caps is limited, projecting only a 2-3% underperformance. However, the report emphasizes that Harris’s policies remain somewhat unclear, making precise forecasting more challenging.

Wells Fargo also points to broader macroeconomic factors, such as the Atlanta Fed’s projected 3.1% GDP growth for Q3, which is higher than consensus estimates. The bank notes that in past instances where GDP has outperformed expectations, small caps have seen significant gains. October 30th’s GDP report is seen as a potential catalyst for the small-cap segment.

In terms of market positioning, Wells Fargo recommends investors add small-cap exposure in anticipation of these tailwinds.

“Time for a tactical shift to smaller caps and select cyclicals related to relative performance, expected returns around the election, and a possible GDP catalyst,” analysts continued.

Long-term, mid-cap growth stocks remain Wells Fargo’s preferred group in terms of risk-reward.

Source: Investing.com