Small cap equities: Will there be another “Trump bump?”

After Trump's election win in 2016, there was a significant rally in U.S. equites, with small caps notably outperforming. In recent weeks small caps have appreciated again due to the anticipation for Trump's domestic and business-focused policies. Given the difference in economic environments from 2016 to now, is 2024’s small-cap “Trump bump” sustainable?

Headline inflation currently sits at 2.6% YoY and has come down substantially since its post-COVID high of 9.1% thanks to Fed rate hikes and shifts in consumer behavior. However, there is still a risk of further spikes in inflation due to Trump’s 2024 tariff proposals, which are significantly more punitive than the tariffs under his previous administration. 

The current inflation environment is also very different from that of 2016. Eight years ago, inflation had been declining for many years and the Fed had expressed little concern for possible consumer price impacts due to Trump’s new tariffs. Since then, the average U.S. consumer (and small business) has become more reliant on Chinese goods, and the Fed has walked a delicate balancing act between taming inflation and maintaining low unemployment. Small caps tend to be more vulnerable to inflation due to thinner margins and less pricing power, so the risk of rising inflation has a perhaps disproportionate effect on small-cap returns.   

Another key economic difference between 2016 and now are interest rates. During the 2016 election, interest rates had been a flat 0.25% since 2009. In 2024, rates were 5.5% for most of the year as in order to cool down an overheating economy after the pandemic, the Fed has been hiking rates up to levels not seen since before the global financial crisis. Only in October did the Fed begin a cutting cycle, and it has stated that it is in no rush to bring rates down quickly. The current high interest rate environment is harmful for small caps (which tend to carry more debt than their larger compatriots) as it makes it harder for them to access and afford capital.   

Although Trump's proposals to decrease regulations, cut taxes, and increase tariffs look to help domestic small caps and support a market rally like in 2016, it's important to understand that the difference in economic environments means that “the same policies, but more” may not produce the beneficial effects they did eight years ago. We caution investors not to get swept up in policy enthusiasm, and to keep a weather eye on fundamentals like earnings quality when assessing whether to chase a small cap rally. 

Julia Rozenfeld contributed to this article. All data sourced from Bloomberg.