Active & Passive Equities Blog

Think Small in a Trade War? Yes, but Think Carefully, Too

18 July 2018
3 min read
Think Small in a Trade War? Yes, but Think Carefully, Too
Samantha S. Lau, CFA| Chief Investment Officer—Small and SMID Cap Growth Equities
James MacGregor, CFA| Chief Investment Officer—US Small and Mid Cap Value Equities; Head—US Value Equities
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As trade tensions escalate, investors are flocking to stocks of smaller US companies, which rely less on foreign sales than their large-cap peers. But in some industries, tariffs could affect smaller companies in unexpected ways.

Small- and mid-cap (SMID) stocks are widely seen as a good place to be when countries unleash tariffs on one another. Investors have embraced this conventional wisdom with gusto, pushing the Russell 2500 Index of US small- and mid-caps up 5.5% in 2018, compared to 2.7% for the S&P 500 through June 30. (Display)

Investors Have Piled into Small Caps as Trade Tensions Heat Up
Investors Have Piled into Small Caps as Trade Tensions Heat Up

Indexed daily returns as of June 30, 2018
Source: Russell Investments, S&P and AllianceBernstein (AB)

Assessing International Exposure

However, as with most pieces of conventional wisdom, the reality is a bit more complicated. It’s true that smaller-cap stocks offer many more opportunities to find US-focused companies than do the diversified multinationals that make up the large-cap universe. Just 38% of firms in the Russell 2500 rely on overseas buyers for more than 10% of their sales, compared to 66% of S&P 500 companies (Display).

Large-Cap Stocks Rely Much More on International Sales than SMID Stocks
Large-Cap Stocks Rely Much More on International Sales than SMID Stocks

As of June 30, 2018
Source: FactSet, Russell Investments, S&P and AllianceBernstein (AB)

Still, the true amount of exposure to international trade goes beyond where a company’s customers are. Further, it varies widely among SMID industries and individual companies—and those variations often require a bit of digging to tease out. Buying an exchange-traded fund that tracks a small-cap index may not offer investors as much protection from protectionism as they think.

From Banks to Truckers

To understand why, think about the banking industry. Banks in the SMID space are primarily regional players, and domestic customers make up the vast bulk of their loan portfolios. But it’s important to know who exactly those customers are. What if they’re construction equipment manufacturers that are being squeezed by rising steel and aluminum prices because of US-imposed tariffs? A regional bank may not take a hit overnight, but if too many manufacturers run into problems and fall behind on their payments, the banks’ loan performance would eventually suffer. The same would go for a rural bank that lends to farmers who must now contend with heavy Chinese tariffs on some of their products.

American trucking companies are another group that may be more vulnerable to global trade disruptions than they first appear. Their routes are, by definition, in the US. But what they’re carrying matters as much as where they’re carrying it. Tariffs tend to raise prices across the board, which in turn raises the risk that consumers and businesses will choose to make do with less rather than spend more. That, in turn, could leave truckers with less freight to haul.

New Risks to Consumer Spending

Consumer spending could be another pain point for all kinds of businesses in a trade war. A restaurant chain based entirely in the US may depend primarily on American appetites for its daily bread. But if, for instance, the American workers on the factories and farms mentioned above lose their jobs or get their hours cut, they aren’t likely to stop by for a bite quite as often.

Investors should be mindful of these nuances and be wary of claims that a trade war is “good” for SMID stocks. The truth is that a trade war will cut deep for companies of all sizes, and it’s important to understand the specific and relative risks to each individual stock in a portfolio.

At the same time, we believe that SMID stocks are a good category in which to hunt for companies with relatively little international exposure. But the key word is hunt. Despite the Russell 2500’s recent positive performance, this isn’t the time to simply follow the index. Careful and active consideration of each firm’s individual exposure to global trade gyrations—and potential second-order effects—is the only way to ensure that positions in smaller stocks can thrive through a larger trade war.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.

About the Authors

Samantha S. Lau was named Chief Investment Officer of Small and SMID Cap Growth Equities in October 2023. Previously, she was the co-chief investment officer of Small and SMID Cap Growth Equities since 2014. Lau joined the firm in 1999 as a portfolio manager/analyst responsible for research and portfolio management for the technology sector of AB’s Small and SMID Cap Growth strategies. From 1997 to 1999, Lau covered small-cap technology companies for INVESCO (NY) (formerly Chancellor Capital Management). Before joining Chancellor in 1997, she worked for three years as a healthcare securities analyst in the investment research department of Goldman Sachs. Lau co-chaired the Women’s Leadership Council at AB from 2019 to 2022. She holds a BS (magna cum laude) in finance and accounting from the Wharton School at the University of Pennsylvania and is a CFA charterholder.

Deep-dive problem solving brought James MacGregor to AB from the sell side at Morgan Stanley in 1998. As Chief Investment Officer of US Small and Mid Cap Value Equities, the pursuit of differentiated perspectives in an ever-changing landscape characterizes his investment philosophy.

"Investing involves risk. A firm that understands that is critically important," MacGregor says. Finding that great opportunity that offers a compelling return for a prudent level of risk is a product of fundamental research and a disciplined process to understand what makes companies tick. "I think we have a best-in-class idea generation engine. Our ability to access a global research footprint creates an undeniable edge." 

The genuine collaboration at AB continues to motivate MacGregor. "You never want to be the smartest person in the room," he says. "I've succeeded in that for 23 years! That's a good thing because I'm constantly being pushed to do better."