Trade War Threatens Small-Cap Stock Juggernaut

In a rush to protect themselves against the fallout from rising tariffs and trade restrictions, investors have been piling headlong into domestic-facing small-cap stocks, paying an "absurd and ridiculous premium" for them, as Larry Glazer of Mayflower Advisors told CNBC. As a result, the small cap Russell 2000 Index (RUT) has been sizzling, delivering a year-to-date gain of 10.4%, versus 6.1% for the S&P 500 Index (SPX). "Now is the time for investors to recognize that valuations trump all else," Glazer cautioned. The five stocks below offer a random sampling of the valuation inflation. (For more, see also: Is There a Trade War on the Horizon?)

These 5 Small Caps Look Too Pricey

Source: Yahoo Finance; data as of July 26.

Overall, the trailing P/E on the Russell 2000 was 81.5 times earnings as of July 20, versus 24.4 times for the S&P 500, per The Wall Street Journal. Looking at forward P/E ratios, the respective valuations were 26.6 times and 17.6 times, also per the Journal.

Glazer told CNBC that he expects worries about trade conflicts to diminish rapidly before the November midterm elections to Congress: "He's [Trump's] going to make a deal. The only people who want a trade war less than the American voters are the American politicians going into midterm elections. And, the only people who want a trade war less than the American politicians and the voters are the Europeans, the Mexicans and the Canadians. So we've got all the cards, all the recipe for let's make a deal, truce or—dare Trump style." (For more, see also: Stocks Plummet Amid Fears of a Trade War.)

When this happens, there will be a "massive rotation" in the market, out of small caps, bringing their valuations back to earth, Glazer predicts. He expects shares of large-cap multinational corporations to surge on the news of a deal, as well as financial stocks, Canadian stocks, and emerging markets such as Mexico.

Meanwhile, not all small-cap stocks are participating in the Russell 2000 rally. For some, tariffs are raising costs on imported materials and components, disrupting business models in the process, The Wall Street Journal reports. The Journal mentions six small caps in its story, including one whose shares actually have outperformed so far in 2018.

6 Small Caps Hurt By Trade Wars

Source: The Wall Street Journal; gains computed through the close on July 26.

Tariffs imposed by President Trump on imported steel and aluminum, as well as on various goods from China, are raising costs for Winnebago,  Art's Way and Acuity, per the Journal. While Winnebago indicates that it buys most of its steel and aluminum from U.S. suppliers, it nonetheless is seeing tariff-related cost pressures, and is concerned that demand may slow as consumers face a higher cost of living. Acuity and Art's Way rely on imported steel, and are being compelled to raise prices in response, which may dampen sales.

Winnebago stated on its latest earnings call, per the Journal, that inflationary pressures unleashed by the tariffs are "the biggest unknown for many companies today." Although Helen of Troy's stock has outperformed both the Russell 2000 and the S&P 500 by wide margins so far in 2018, its management also voiced concerns about the negative impacts of tariffs in their most recent earnings call, as did MSC and Herman Miller, the Journal adds.