A Trade War Could Be an Opportunity for Small Cap Stocks, Says Barclays

The recent delay in tariffs against Mexico and Canada highlights the uncertainty surrounding the trade war, which has significant implications for prices, interest rates, and the overall economy. According to Stefano Pascale, head of equity derivatives strategy at Barclays, this uncertainty will continue to impact equity markets. Indeed, Barclays economists estimate that implementing 25% tariffs would increase U.S. inflation by 10-15 basis points and reduce GDP by 25-50 basis points. However, this could create an opportunity for small-cap stocks.

Since the potential impact on interest rates is significant, the Federal Reserve may be forced to cut rates more aggressively in response to lower growth. This could lead to a scenario where small-cap stocks outperform in an equity sell-off. Pascale notes that if this scenario plays out, investors may consider buying S&P 500 (SPX) puts while selling Russell 2000 (IWM) puts, which could provide a hedge against potential losses.

Historically, this strategy has yielded favorable returns, especially in extreme market conditions. Pascale also notes that a trade war would disproportionately harm internationally exposed companies, while lower interest rates would benefit small-cap stocks. Interestingly, commodity trading advisors are currently positioned to be short on the Russell 2000, while their exposure to the S&P 500 is higher. Therefore, the volatility spread between the Russell 2000 and S&P 500 remains historically high.

Is the S&P 500 a Buy?

Turning to Wall Street, analysts have a Moderate Buy consensus rating on the SPDR S&P 500 ETF Trust (SPY) stock based on 400 Buys, 98 Holds, and seven Sells assigned in the past three months, as indicated by the graphic below. After a 24% rally in its share price over the past year, the average SPY price target of $688.82 per share implies 14.6% upside potential.

See SPY’s Holdings