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Forget Trade Fears, Tap Economic Boom With Small-Cap Stocks

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After mega caps frenzy at the start of June, investors again started to hunt for small-cap stocks, which had a strong run from February-end through May in more than a decade and a half. This is especially true against the backdrop of renewed trade tension and bouts of upbeat economic data that has rekindled the appeal for the pint-sized stocks.

Trade Tension Flares Up Again

Trade disputes between the United States and China heated up again on Friday after Trump unveiled a list of goods worth $50 billion targeted for 25% tariff as previously mentioned. In retaliation, the second-largest country also announced that it will slap 25% tariff on 659 American goods for a similar amount and in a similar fashion in two waves.

Additionally, trade tensions between the United States and its biggest allies — the European Union, Canada and Mexico — are adding to the global trade war woes. This is because Trump has imposed a 25% tariff on steel and 10% on aluminum imports on them from on national security grounds, ending their temporary exemptions that expired on Jun 1. This move has led to retaliation from these countries targeting American products worth billions of dollars.

The ongoing disputes would boomerang and hit economic growth across the world, leading to job losses. According to the International Monetary Fund, the trade spat has clouded a favorable outlook for the global economy, which is on track to grow at its fastest pace since 2011 this year and the next.

In such a scenario, small-cap stocks are less prone to these events and well insulated from international headwinds. The pint-sized stocks are considered safe and better plays if political issues or economic turmoil creeps into the picture.

Accelerating U.S. Growth

The domestic economy is piping hot given the raft of upbeat economic data. American manufacturing is enjoying a 21-month winning streak, average hourly wages have been rising with 2.7% year-over-year growth, and unemployment has dropped to 3.8%, which is the lowest level since 2000.

Consumer spending, which accounts for more than two-thirds of U.S. economic activity, rose the most in five months by 0.6% in April, while consumer confidence rebounded near the 18-year high in May. Per the latest survey, consumer sentiment rose to the highest level in three months early in June. U.S. retail sales also rose by the most in six months in May. So clearly, all the latest data points signal acceleration in the economic growth after the slowdown in the first quarter. Further, the massive $1.5-trillion tax cut will perk up the economy and save billions for corporations, boosting job growth and earnings.

As the pint-sized stocks are closely tied to the U.S. economy and do not have much exposure to the international market, they tend to outperform on encouraging domestic economic fundamentals.

Tax Reform

Small-cap stocks are the biggest beneficiaries of the tax cut as stocks on the Russell 2000 pay higher taxes with a median effective tax rate of 31.9%. In comparison, the larger, multi-national companies on the S&P 500 pay a lower median effective tax rate of 28%, while the tax rate for 30 mega-cap stocks on the Dow Jones Industrial Average is even low at 23.8%.

5 Stock Picks

Given the bullish economic fundamentals but looming trade war fears, investors should bet on solid stocks in the small-cap space as they are extremely volatile and could lead to huge losses compared with large and mid-cap counterparts in a short span. As a result, we have presented five small-cap stocks that have a top Zacks Rank #1 (Strong Buy), Growth Score of A, positive earnings estimate revision for fiscal 2018 over the past 30 days and double-digit earnings growth for fiscal 2018. All these suggest their continued outperformance in the coming months.  

You can see the complete list of today’s Zacks #1 Rank stocks here.

Comtech Telecommunications Corp. (CMTL - Free Report)

This company designs, develops, produces and markets innovative products, systems and services for advanced communications solutions. Comtech has an earnings estimate revision of five cents for the fiscal (ending August 2018) over the past three months and has an expected earnings growth rate of 247.06%.

Rocky Brands Inc. (RCKY - Free Report)

It is a leading designer, manufacturer and marketer of premium quality footwear and apparel marketed under a portfolio of well-recognized brand names including Rocky Outdoor Gear, Georgia Boot, Durango, Lehigh and the licensed brand, Dickie. The company has seen positive earnings estimate revision of 10 cents for this year over the past three months and has an expected earnings growth rate of 29.31%.

Nanometrics Incorporated

Nanometrics is a leading provider of advanced, high-performance process control metrology and inspection systems used primarily in the fabrication of semiconductors and other solid-state devices, such as data storage components and discrete including high-brightness LEDs and power management components. The company has seen solid earnings estimate revision of 60 cents over the past three months for this year and has an expected growth rate of 83.74%.

Luxfer Holdings PLC (LXFR - Free Report)

This is a materials technology company specializing in the design, manufacture and supply of high-performance materials, components and gas cylinders. Luxfer Holdings has seen positive earnings estimate revision of 9 cents for this year over the past three months and has an expected growth rate of 26.47%.

Echo Global Logistics Inc.

It is a leading provider of technology-enabled transportation and supply chain management services, delivered on a proprietary technology platform, serving the transportation and logistics needs of its clients. The company has seen solid earnings estimate revision of 17 cents for this year over the past 90 days, representing year-over-year growth of 66.29%.

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