Since the initial reports suggesting a potential Republican triumph across the White House and Congress, a remarkable shift has been observed in the global financial landscape. The S&P 500, Nasdaq, and Dow Jones indices all witnessed a notable upward trend. On November 5th alone, the small-cap Russell 2000 closed nearly 6% higher. This same day, the US dollar index reached its highest point since July, strengthening against other global currencies. Meanwhile, the euro faced a decline due to expectations of increased tariffs on European goods. Additionally, a particular asset soared from USD 68,000 to USD 99,000 between election day and November 22.
Trump's Victory and Market Reactions
Investors around the world, including those in Europe, responded swiftly to the election result of the world's largest economy. One effective way to analyze their asset allocation decisions is by observing the exchange-traded funds (ETFs) market. ETFs, by their nature, are highly tradable and suitable for short-term tactical positions. We conducted an analysis of the weekly flows of certain categories of ETFs - those most influenced by the US election outcome - over a four-week period starting from the week of the election.In summary, European investors reacted to Trump's victory by purchasing US equity ETFs, both large-cap and small-cap, as well as global equity strategies where US stocks hold a significant weight. Concurrently, they sold precious metals exchange-traded commodities, mostly those exposed to gold, emerging markets equities, and thematic strategies focused on clean energy. However, the situation regarding US-China relations and the outlook for the Chinese stock market is more complex.ETF Investors and Their Bets on US Small- and Mid-Caps
While absolute numbers provide some insight, a more profound understanding of the strength with which assets have moved can be gained by using the organic growth rate. For any given period, the organic growth rate is calculated as the cumulative flow for that period divided by the beginning total net assets.In this regard, US small-caps and US mid-caps have been the major beneficiaries of Trump's election. For instance, in the first two weeks after the election, US small cap equity ETFs attracted around EUR 2.17 billion in net inflows. To put this into perspective, the category's best monthly result on record (July 2024) saw EUR 1.11 billion in inflows. The Morningstar US Small Cap Index has returned 11.6% since the election, while large-company stocks, which have been leading the two-year bull market, gained 8.1% (in euros as of November 26). Strategists attribute the outperformance of small-company stocks to investor enthusiasm for their prospects under new Republican policies, along with the relief that the uncertainty surrounding the election has finally ended.The Risks and Rewards of Small Caps
Small caps are undoubtedly risky, but under the right conditions, they can significantly enhance returns and improve the diversification of a broader portfolio. One of the attractions of small caps is that some of them have the potential to grow into mid- and large-cap stocks. However, the risk is that the majority will not. Small-cap investors benefit from a firm's growth as its business expands. By investing in a portfolio of these businesses through a small-cap ETF, risk and opportunity are spread across hundreds or even thousands of stocks.Small companies are risky partly because they do not typically possess the same competitive advantages as larger firms. Only 2% of companies in the small-cap index have a wide Morningstar Economic Moat Rating, compared to 76% of firms in the large-cap index. At the same time, small caps should have an edge during bull markets and are more sensitive to interest rates, which can fuel further growth in low-rate environments.Morningstar's Chief US Strategist Dave Sekera stated in his regular quarterly analysis and outlook that small cap valuations still remain far below the US market average and may present an opportunity for ETF investors willing to take on the risk.The author or authors do own shares in any securities mentioned in this article. Find out about Morningstar's editorial policies.READ MORE