A pair of analysts is recommending that investors tread lightly in the global landscape for small-and-midcap stocks following a strong post-election rally fuelled by hopes they would benefit from policies implemented by US President Donald Trump.
In a note to clients, JP Morgan global small and midcap analyst Eduardo Lecubarri recommended buying puts, an investment device that acts as insurance in the event of a decline, amid added risk from the Trump administration's early focus on protectionist global trade over fiscal stimulus.
Ben Laidler, global equity strategist at HSBC, said he was cautious on smaller names compared with larger stocks, with a pickup in corporate earnings needed to justify the recent rally in world markets, which he urged investors not to chase.
In the United States, the indexes of smallcaps have surged since the election, with the Russell 2000 index up more than 14 percent and the S&P smallcap 600 index up more than 15 percent since Trump's victory on November 8.
S&P's index of midcap stocks is up more than 11 percent over the same time. The largecap benchmark S&P 500 has risen nearly 7 percent since the election.
Both analysts said the excessive optimism of investors which has fuelled the rally was reason for concern.
Lecubarri noted that low volatility and a high relative strength index (RSI) reading were signs of investor overconfidence in a year that may prove to contain the most political risk over the last twenty.
Laidler noted that US smallcaps have also reaped the rewards from recent strength in the dollar, which benefits domestically focused names, as well as expectations Trump's proposed tax cuts and deregulation will spur US economic growth.
HSBC believed the smallcap outperformance was dependent on a strong earnings recovery, which is possible with improved US growth. However, the firm said profit forecasts were trending lower, suggesting investors may be pricing in a sharper earnings rebound than is likely.
While both analysts have expressed reservations over smaller names, JP Morgan still maintains an overweight on them globally and recommends buying puts to protect against a downdraft of 5 to 15 percent in the market.