Small caps seen as a good bet if Democrats push for another stimulus, shares surging nearly 4%

Published Wed, Jan 6 202111:19 AM ESTUpdated Wed, Jan 6 20214:14 PM EST

The Democrats are closing in on two Senate seats in Georgia, edging the party closer to control of the chamber. Investors are betting a possible Democratic majority means more stimulus is coming and small-cap stocks will benefit because they are seen as more reliant on the pace of the economy than bigger shares. Shares of the Russell 2000 popped nearly 4% on Wednesday. The group would benefit from further fiscal aid as the small companies grapple with the ramifications of the pandemic, investors said. "Small caps are more economically sensitive so the faster GDP grows, the more earnings growth we're going to get in small caps," said Steven DeSanctis, small- and mid-cap strategist at Jefferies . In a closely contested race, Democrat Raphael Warnock defeated Republican Sen. Kelly Loeffler in their runoff, according to NBC News projections, and Democrat Jon Ossoff leads Republican David Perdue in the second race. NBC News said the Ossoff-Perdue race was too close to call, but Ossoff claimed victory. If Ossoff is victorious, it would create a 50-50 Senate that Democrats would control, thanks to having the tiebreaking vote in Vice President-elect Kamala Harris. While some investors fear the higher taxes and increased regulation from the party, it is widely expected that a Democrat-held Senate would push for a more robust stimulus package. "We're looking for an additional $1 trillion of stimulus which translates to about one additional percentage point of GDP," said DeSanctis. "Small outperforms large, value outperforms growth. Cyclicals over secular growth and bond proxies." The iShares Russell 2000 ETF climbed 3.3%. The Vanguard Small Cap Value ETF rose 2% and the Schwab U.S. Small-Cap ETF gained 3%. ETFs that track not only small shares, but value stocks in that group were up even more. The iShares Russell 2000 Value ETF rose more than 4% on Wednesday and the S & P Small Cap 600 Value ETF gained nearly 5%. "If you get the Democrats in, you could argue there's going to be more stimulus, that means you go buy the retailers," CNBC's Jim Cramer said on "Squawk on the Street" on Wednesday. Retailers like Deckers, RH and BJ's Wholesale club are among top holdings in many small cap ETFs. "This is what we saw in late October we started talking about 'blue wave': stimulus driving cyclicals," said DeSanctis. "Plus the steeper yield curve benefits the banks." In November, the Jefferies estimated the benchmark Russell 2000 would rise to the 2,050 level by the end of 2021, which represented a 12% jump from levels at the time. This marked the firm's most bullish for the index since 2003. However, after the best quarter on record for the Russell 2000 and then Wednesday's surge, Jefferies' 2021 target represents less than a 1% gain. At one point one Wednesday the Russell 2000 surpassed the year-end target. "You anticipate this playing out over the course of 2021 and unfortunately it plays out over a couple of days," DeSanctis added. "We looked pretty optimistic at the end of November but after December now we look pretty conservative." Jefferies estimates 40% earnings growth for the Russell 2000 in 2021. Proceed with caution The small-cap benchmark returned an impressive 18.4% in 2020. The group more than doubled from its March low and the Russell 2000 had its best quarter ever in the fourth quarter of last year. The group outperformed its large-cap counterparts as investors rotated into beaten-down value stocks on the back of the positive vaccine developments. However, DeSanctis warned about the group getting ahead of itself. The Russell 2000 is now trading at 31.7 times earnings, its highest multiple since 1979. "December was a little scary for me, just from pure speculation in the market. Seventy-two percent of the Russell 2000 stocks are trading more than 10% above their 200-day moving average, we've never seen that before," said DeSanctis. Small cap ETFs saw $12 billion in inflows in November and December. "Some of the stuff kind of reminds me of 1999. You think about retail investors and how influential they've been on stock prices. We estimate 45% of all trading volumes in December was retail investors," DeSanctis said.

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Shares of the Russell 2000 popped nearly 4% on Wednesday.