It’s Time for a Short-Term Small-Cap Trade: Wells Fargo

Current market conditions present an appealing opportunity for a short-term small-cap trade, according to analysts from Wells Fargo. They highlighted that the combination of a tightly contested U.S. presidential race and favorable economic factors makes small-cap stocks particularly enticing in the near term.

The analysts noted that the “50/50″ nature of the presidential race leads to markedly different returns for small-cap stocks, especially if there is a victory for Trump. They stated, “Small caps are expected to have a positive near-term relative return, as the Presidential race resembles a coin flip with only five weeks remaining.”

Wells Fargo believes that small-cap returns are positively skewed, projecting considerable short-term outperformance in the case of a Trump triumph, while indicating limited downside should Vice President Harris win. They predict a 5-10% outperformance by small caps within 1-3 months following a Trump victory, drawing parallels to market behavior after the 2016 election and the attempted assassination of Trump in July 2024. After the 2016 election, for instance, small caps surged 15.7% by year-end, in contrast to a 5% rise in large-cap stocks. Likewise, post-assassination attempt in July 2024, small caps recorded a 6.4% gain by the month’s end, while large caps fell by 1.6%.

Even if Harris wins, Wells Fargo anticipates limited downside for small caps, estimating only a 2-3% underperformance. However, they caution that Harris’s policy directions remain somewhat ambiguous, complicating precise forecasts.

The analysts also pointed to broader macroeconomic indicators, such as the Atlanta Fed’s anticipated 3.1% GDP growth for the third quarter, which exceeds consensus forecasts. Historically, small caps have performed well when GDP figures beat expectations. The upcoming GDP report on October 30th is viewed as a potential catalyst for small-cap performance.

Wells Fargo recommends that investors consider increasing their small-cap exposure in light of these favorable developments. They assert, “It’s time for a tactical shift toward smaller caps and selected cyclicals, influenced by relative performance, expected returns surrounding the election, and a potential GDP catalyst.”

Long-term, Wells Fargo continues to favor mid-cap growth stocks as the preferred choice in terms of risk-reward.