With Trump tariffs taking effect on Canada, Mexico and China from March 4, 2025, geopolitical tensions are heating up. Canada and China, too, imposed sweeping retaliation on a host of products. Many investors want to take resort to small-cap stocks and ETFs as the large caps are more impacted by the geopolitical tensions.
This is because large caps are export-oriented and more vulnerable to global trade policies. On the contrary, small caps are more exposed to the domestic economy. However, in the current scenario, small caps cannot come to investors’ rescue.
Strategas Securities’ managing director of investment strategy Ryan Grabinski challenges market expectations, citing past trends, as quoted on Yahoo Finance. During Trump's 2018 tariff implementation, small caps failed to outperform, despite investor hopes. He warns that the same pattern could be repeated under the new trade regime.
Caution Amid Earnings Growth Projections
While small caps are expected to outpace larger companies in earnings growth during the second half of the year, Grabinski remains skeptical. "They're not going to have the same boost they saw from 2017 to 2021," he told Yahoo Finance, adding, "It's not exactly a great place to hide."
iShares Russell 2000 ETF IWM is off more than 7% so far this year (as of March 4, 2025) and has lost about 10% over the past month.
What’s Wrong With Small Caps Currently?
Is the U.S. economy slowing? Economic data for the first quarter of 2025 indicates a potential contraction, according to the Federal Reserve Bank of Atlanta's GDPNow tracker, as quoted on CNBC. The model now predicts a 1.5% decline in GDP for the January-to-March period, a sharp decline from its previous projection of 2.3% growth.
The latest tariffs represent an escalation in Trump’s trade policies, surpassing the economic impact of his first term if maintained. According to the Tax Foundation, tariffs from 2018-2019 cut U.S. GDP by 0.2%, with the new measures expected to surpass this loss, as quoted on Yahoo Finance (read: Trump Tariffs & Retaliatory Moves Put These ETF Areas in Focus).
Meanwhile, the University of Michigan’s consumer sentiment index fell to 64.7 in February — a nearly 10% decline — as consumers voiced inflation concerns, particularly due to the likely new tariffs. Trump tariffs are likely to raise inflation in the United States, which in turn will weigh on domestic companies. The Fed may also delay in the next rate cut in order to contain increased inflation.
Alternative Investment Opportunities
Rather than focusing on small caps, Grabinski suggests looking at industries that stand to benefit from tariffs. He specifically highlights insurance and utilities as sectors with strong potential in the current economic environment.
Insurance
iShares US Insurance ETF IAK has gained about 7% so far this year and advanced about 4.6% over the past month. A steepening yield curve have boosted the insurance stocks this year. Insurers invest heavily in bonds and equities, and the current high-interest-rate environment has boosted their investment income. Moreover, strong financial performances and strategic initiatives from leading companies have led to the gains.
Note that in late February, French insurer AXA reported better-than-expected full-year earnings, thanks to higher premiums from individual insurance policies, fewer claims and increased margins for its natural catastrophe coverage.
In late February, Aviva reported that its operating profits for the year to the end of December exceeded forecasts. This performance was driven by a 14% increase in general insurance premiums and a 23% surge in net inflows to its wealth business.
Utilities
Utilities Select Sector SPDR Fund XLU has gained more than 3% in the year-to-date frame and has advanced more than 1% over the past one month.The utility stocks also get a safe-haven tag. Utilities provide essential services such as electricity, water and natural gas, which people and businesses rely on regardless of economic conditions. This makes the sector non-cyclical, meaning demand remains stable even during recessions.
Utilities can often pass increased costs to consumers through regulated rate adjustments. Moreover, the latest AI boom has brightened the demand for utilities even more as this sector satisfies the AI industry’s energy needs (read: Time for Defensive Sector ETFs?).
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This article originally published on Zacks Investment Research (zacks.com).
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
