Small-cap stocks have a lot riding on the upcoming election.

When former President Trump was elected in 2016, there was a massive rally in U.S. small-cap stocks. One central catalyst was the U.S. corporate tax rate cut, as small-cap companies tend to have effective tax rates closest to the headline figure—at that time, 35%. Because President Trump won the election with a majority in both the U.S. House of Representatives and the U.S. Senate, he was able to lower this rate to the current level of 21%.¹

Tax rates will be renegotiated next year, and small caps again will be in focus.

But we were curious if a rally in U.S. small-cap stocks happened solely in 2016 or if there is a pattern beyond just that single year.

The WisdomTree U.S. SmallCap Fund (EES)

The WisdomTree U.S. SmallCap Fund (EES) was launched on February 23, 2007. It is designed to track the total return performance, before fees and expenses, of the WisdomTree U.S. SmallCap Index.

The most well-known U.S. small-cap equity index is the Russell 2000 Index. As of September 30, 2024, 27.37% of the weight in this Index was in companies that did not deliver positive earnings over the past 12 months.² WisdomTree’s approach seeks to include only small-cap companies with positive core earnings and to also weight these stocks by their earnings, thereby lowering the overall price-to-earnings (P/E) ratio.

An index of small-cap companies with a lot of domestic earnings should be sensitive to changing tax rates.

Figure 1: Standardized Performance

In figure 2, we evaluate 3, 6 and 12 months after all of the elections, midterm and presidential, for which EES has had live performance history.

• 2008 stands out because the election itself occurred during what we now look back on as the global financial crisis of 2008–2009. It is remarkable how equity returns looked three months after the election and then how this picture had massively shifted toward an equity performance recovery merely nine months later.
• 2012, 2016 and 2020 saw some strong equity market returns, especially 12 months after the election. Notably, these were the presidential years.
• The midterm years were notably lower, return-wise.

Figure 2: Return Data for 3, 6 and 12 Months Following Elections

Conclusion: The 12 Months Following U.S. Elections Have Been Largely Positive for U.S. Equities, Particularly Profitable Small Caps

When we calculated the simple averages of the returns of the different periods shown in figure 2, we saw that, on average, looking at 12 months following the election represented the strongest overall group of returns. For most of these elections, the picture was positive. EES had a stand-out year in 2020.

The causality in any of these cases can be tricky. We mentioned 2016 because there was 1) a tax policy change discussed in the campaign and then 2) a sweep across the presidency, U.S. Senate and U.S. House of Representatives by a single party. This allows us to at least build a narrative that can connect tax policy expectations to equity returns.

In 2020, we were in the midst of the COVID-19 global pandemic. Equity markets crashed until March 23, 2020, and then rallied significantly through the end of the year. There was a lot of fiscal and monetary stimulus being implemented during this time, so it is a bit of an outlier relative to the others.

Figure 3: Average Returns for 3, 6 and 12 Months after Elections

Now, even with all of that said, as divided as the rhetoric may sound as we approach the 2024 U.S. election, if history has been any guide, it has been a losing proposition, for the most part, to bet against U.S. equity markets.

There are never guarantees as to what we may see, return-wise, but we’d remind people that, frequently, the most likely outcome is a divided government where much of the current policy simply continues along.

¹ Source: Benjy Sarlin, “Republican-led Congress passes sweeping tax bill,” CNBC.com, 12/20/17.

² Source: WisdomTree; specifically, WisdomTree’s Fund Comparison tool within its broader PATH family of tools, with data accessed as of 10/13/24.