US small caps to outperform large caps in 2021, says BNP Paribas

Jan 14, 2021
Bank doesn’t see corporate tax hikes high on the list of Democrats’ priorities

BNP Paribas expects US small caps to outperform large caps this year and doesn’t expect to see a corporate tax hike in the early stages of the Joe Biden presidency.

With six days to go until the inauguration of Joe Biden as the next president of the US, representatives for BNP Paribas believe the markets have priced in the results of the election and that the Democratic sweep of the presidency, Senate and House of Representatives increases the likelihood of further government stimulus passing quickly.

Asked at a press conference yesterday (January 13) about the political risks of the transition of the presidency from Donald Trump to Biden, Daniel Morris, chief market strategist and co-head of the investment insight center at BNP Paribas, said: ‘They’re significantly lower now that we’ve passed the elections. Biden has won and the Democrats have control of Congress. The markets don’t appear to be very worried about it and I would share that assessment.’

Pamela Woo, head of US and global thematic equities at BNP, agreed, adding that small caps have fared better under a Democratic Congress during the last 40 years.

‘We think the Democratic sweep should further support small caps, relative to large caps,’ Woo said. ‘After the vaccine efficacy was announced in the fourth quarter [of 2020], it was a strong one for small caps. Given the expectations for earnings recovery and the economic stimulus, we think small caps have more road to run.’

This outlook is informed by the performance of the Russell 2000 during 2020, when it had its worst ever quarter followed by its best ever quarter, Woo said: ‘We expect small caps to outperform large caps based on their better earnings recovery.’

From a sector perspective, she said the bank expects healthcare, materials, technology and staples to deliver earnings growth year-on-year.

Don’t expect corporate tax hikes immediately

In 2017 Trump spearheaded the Republican efforts to overhaul US corporate taxes, ultimately reducing the rate from 35 percent to 21 percent. During the 2020 election cycle, the tax rate was a source of frequent discussion, with concern from some Republicans that big wins for Democrats would lead to a reversal of the corporate tax cuts that The New York Times estimates have saved corporations $5.5 bn.

But Woo doesn’t share the concern. ‘We think the first 100 days will be spent on the coronavirus, as well as government appointments,’ she said. ‘We think [corporate taxes] are further out.’

Are the markets detached from economic reality?

During the press conference, Morris also addressed concerns about ‘this seemingly wild disconnect between the returns we have in the equity markets and what we know has happened in the economy’.

The Covid-19 pandemic has caused a 10 percent decrease in US GDP, compared with a 3 percent decrease following the global financial crisis, Morris said. But the government response, through fiscal stimulus, has differed greatly.

During the global financial crisis, personal income and corporate revenue fell, but government intervention means personal incomes have since increased, according to Morris, and corporate revenue has more recently decreased much less than it did during the global financial crisis. With this in mind, the response of the markets has been ‘quite rational’, he concluded.   

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