Wall Street rallies as volatility ebbs

US small-capitalisation stocks are widening the performance gap against their larger counterparts, highlighting the recent revival of the “Trump trade”, in spite of the tech-heavy Nasdaq Composite posting a new record high on Monday.

The Russell 2000 index of small-cap equities has boosted its post-US election rise to 17 per cent, from as low as 12.6 per cent on March 22. The move, which has accelerated over the past 10 days, has lifted the Russell’s relative gain over the large-cap S&P 500 to about 6 percentage points, up from 2.6 percentage points for the period.

Small-caps are seen as something of a barometer for Wall Street’s enthusiasm for the Trump administration, since they typically face higher tax rates than “large-caps” and are more exposed to the domestic US economy.

The group surged immediately following the November election, far outpacing the gains in large-caps, but later pared back gains after the Trump administration’s failure to pass measures to repeal and replace Obamacare in Congress, highlighting the fractures in Donald Trump’s Republican party.

The Trump administration reinvigorated some optimism on Monday, however, after it said it would seek a reduction in the corporate tax rate to 15 per cent, a promise investors are likely to closely scutinise.

By the close of trading on Monday, the Nasdaq Composite was at a record high, up 1.2 per cent to 5,983, while the S&P 500 gained 1.1 per cent to 2,374 and the Dow Jones Industrial Average rose 1.1 per cent to 20,763.

Hussein Sayed, chief market strategist at FXTM, said tax reform was “a crucial test for the new US administration, especially now that markets have grown sceptical of its ability to deliver”.

Other risks loom as well. Some strategists have cooled on the prospect of more domestically-focused companies out-performing multinationals thanks to emerging currencies trends.

“The outlook for US firms with the highest domestic sales exposure is less favourable than we had expected post-election,” Goldman Sachs strategists note, adding that, “our FX strategists recently reduced their expected trajectory of the trade-weighted US dollar given strong global growth, rhetoric from the Trump Administration, and a cautious Fed”.

The greenback is off by 3.1 per cent since the start of the year against a basket of six global currencies, a move that has been bolstered further by easing political uncertainty in Europe.

The Goldman strategists also note that with Trump administration potentially taking a lighter approach than initially expected on trade, the insulation provided by domestically-oriented firms has become less important.

Meanwhile, a widely tracked measure of implied volatility in US stock markets registered its largest intraday drop since the US election, after Sunday’s French election result bolstered global investor sentiment.

The CBOE’s Vix volatility index fell from 14.63 on Friday to 10.84 on Monday as results from the first round of voting in France affirmed Emmanuel Macron as the favourite in next month’s second round against Marine Le Pen to become the country’s president.

Other measures of market volatility also subsided, including those for gold, currencies and interest rates. Implied European stock volatility registered the biggest percentage decline on record, according to the VStoxx index.

“It is totally due to the French election,” said Mandy Xu, an equity derivatives strategist at Credit Suisse. “As the risk of a Le Pen victory has come down, volatility has also come down.”