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The Safest Bets In A Trade War

With worries escalating about a trade war, there’s plenty of “blood in the streets.”

But you wouldn’t know it looking at small cap stocks.

Since the start of the year, the Russell 2000 small cap index has gained 7%. Meanwhile, the Dow Jones is now down 3% on the year with the S&P 500 up 1%.

Of course, the rise of small cap stocks makes perfect sense in chaos.

For one, the Russell 2000 index sees 78.6% of revenues from the U.S., according to Yahoo Finance, which means they’re domestically focused with little exposure to foreign markets.

Meanwhile, large-cap indexes like the Dow Jones see just 52.8% from the U.S.

“We continue to recommend small-caps as a 'catch-all trade' for its higher cyclical, reflation, and tax policy exposures, as well as lower sensitivity to ongoing trade risk," said JPMorgan analyst Dubravko Lakos-Bujas, as quoted by CNBC.

Two, small caps are still benefiting from tax reform and deregulation, the effects of which haven't been completely priced in, in our opinion.

Even analysts at Morgan Stanley have noted that small cap stocks are well positioned to see positive effects form business-friendly deregulation.

"While the relative outperformance of small caps we have seen is a lot, forward growth expectations indicate it is likely to continue," Mike Wilson, Morgan Stanley’s chief US equity strategist said, as quoted by Business Insider. "The growth differential between small and large caps may be widening even further from here which should extend the relative outperformance."

JP Morgan also noted that small caps are really shielded from the escalating trade war risk. In fact, a good chunk of the small cap rally, they believe, comes courtesy of a flight to safety by investors greatly concerned about geopolitical issues and trade war threats.

Plus, according to the NASDAQ:

The Russell 2000 has been leaving the S&P 500 in the dust over the past four decades during periods of economic turbulence, recessions and financial crises. It managed to outperform the large-stock benchmark by 80 percent in 1979-1983, 50 percent in 1990-1994 and 114 percent in 1994-2014.

In our opinion, it’ll be hard to shake that type of investor support for small-caps any time soon.

Stay tuned for more small-cap opportunities in the next issue of The Cheap Investor.