5 Top Small-Cap Picks To Shrug Off Lingering Trade Tensions

Wall Street witnessed severe volatility last week as the U.S.-China trade war, which was heading for a truce, stalled abruptly for an indefinite time period. The blue-chip Dow 30 Index lost 2.1%, the highest weekly loss since March. The market's benchmark S&P 500 and tech-heavy Nasdaq Composite Indexes shed 2.2% and 3%, respectively, marking the biggest weekly losses since Dec 21, 2018.

Re-escalation of Trump-imposed tariffs are likely to significantly disrupt the global supply chain system and halt economic activities worldwide. At this juncture, small-cap stocks are likely to emerge as diamonds in the rough, pushing aside the large-cap stocks. Strong fundamentals of the U.S. economy and immunity to external disturbances have raised these stocks' popularity.

Lingering Trade Tensions

The trade conflict between the two largest trading countries heightened yet again in his month when it was finally moving toward mutual agreement. On May 10, the U.S. government hiked existing tariff rates to 25% from 10% on $200 billion of Chinese exports.

In 2018, the Trump administration imposed 25% tariff on $50 billion of Chinese goods. Moreover, President Trump threatened to levy 25% further tariff on another $325 billion of Chinese goods. The total amount will surpass China's yearly export to the United States.

U.S. officials are accusing China of “erosion of commitments” and backtracking on promises made during the negotiation process. China, which has already imposed 10% tariff on $110 billion of U.S. goods, warned of further retaliatory measures.

However, negotiations between high-level officials of both courtiers to reach a trade deal is still on as President Trump expressed his hope, no timeline has been provided by either country and several industry experts believe that this negotiation process may continue next year.

Special Features of Small-Cap Stocks

Small-cap stocks may become hidden gems especially as volatility returned in Wall Street and is likely to stay in the near term. Notably, the Russell 2000 (RUT) -- the benchmark index of small-cap stocks -- has jumped up 16% year to date.

Small-cap stocks are mostly immune to any external shock since the United States is the primary market of their products. This is aiding this segment to outperform the broader market defying extreme volatility.

Owing to their domestic business strategy, small-cap stocks are immune to the movement of the U.S. dollar. A strong U.S. dollar will make exports of large companies uncompetitive. However, small-cap stocks remain unaffected by foreign exchange volatility.

Small-cap companies generally benefit first from an improving domestic economy. A strong economic condition tends to coincide with rising interest rate. However, in order to fund expansion, small-cap companies are less likely to take the debt route compared with their large peers making them less sensitive to the interest rate movement.

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Additionally, reduction of corporate tax from 35% to 21% is a major catalyst for small-cap companies. These companies book almost all of their revenues in the homeland. As a result, a significant reduction in corporate tax rate is immediately accretive to their cash flow.

Our Top Picks

At this stage, it will be prudent to invest in small-cap stocks with a favorable Zacks Rank and strong growth potential. We have narrowed down our search to five stocks with a Zacks Rank #1 (Strong Buy). You can see Zacks Investment Research