Small-cap stocks have been enjoying a stellar 2018, when their larger counterparts are suffering from simmering trade tensions. The Russell 2000 gained 7% in 1H18, significantly more than the S&P 500, which advanced only 1.7% over this period.

But after an eight-week long winning streak, the small-cap benchmark declined significantly last week. Analysts are pointing toward historical data to indicate that the Russell 2000 has underperformed the S&P 500 in July over the last 18 years.

However, the consensus is veering around to the view that small-caps will likely lose the least during a trade war. Their domestic focus and the fact that they will be the largest beneficiaries of tax cuts also make them strong investment options. Currently, picking select small-cap stocks looks like a smart move.

July’s Historical Trends Loaded Against Small Caps

After a sharp downturn on Feb 8, the Russell 2000 has gained 12.4%, easily outperforming the S&P 500’s 3.6% advance. During this time, the Russell 2000 has advanced over eight straight weeks, a winning streak which ended only last Friday.

Some analysts believe that this loss presages a longer decline for small caps. Julian Emanuel from BTIG has warned that the Russell 2000 has historically underperformed the S&P 500 in July. The small-cap index has gained 1.1% lesser than the broader market benchmark during this month since 2000.

Also, the small business optimism index released by the National Federation of Independent Businesses posted its second-highest ever reading in May. This leaves little room for improvement, raising chances of underperformance by small caps.  

Domestic Focus, Tax Cuts are Key Strengths

But investors have flocked toward small-caps this year and this trend is likely to continue. Data from Lipper indicate that small-cap growth funds received inflows worth $595 million over last week, the seventh successive week of gains.

Lora Calvasina of RBC Capital Markets thinks small-caps could continue to outperform their larger counterparts despite the prevailing headwinds. The Trump administration’s protectionist agenda will likely to lead to a trade war, which has no winners. But small caps could lose the least in such circumstances.

This is because the domestic focus of this investment category shields them to a large extent from trade conflicts. Further, they are also less susceptible to the negative impact of a surging U.S. dollar which eats into the profits of large multinationals.

Small caps will also be the biggest beneficiaries of Trump’s tax cuts. While large caps will see their effective rates fall from 28% to 24% as a result, small-caps will face a rate of only 21%. 

Our Choices

Historical trends for the month of July seem to be loaded against small caps. It also seems difficult for small business optimism to rise any further, which indicates that a longer downturn could be in sight for this class of stocks.

But small caps could lose the least during a trade war. Their domestic focus and tax cuts are other factors working in their favor. However, picking winning stocks may be difficult.

This is where our VGM Score comes in. Here V stands for Value, G for Growth and M for Momentum and the score is a weighted combination of these three scores. Such a score allows you to eliminate the negative aspects of stocks and select winners. However, it is important to keep in mind that each Style Score will carry a different weight while arriving at a VGM Score. 

We have narrowed down our search to the following stocks, each of which has a Zacks Rank #1 (Strong Buy) and a VGM Score of A. 

Turtle Beach Corporation (HEAR - Free Report) is an audio technology company.

Turtle Beach’s expected earnings growth for the current year is more than 100%. The Zacks Consensus Estimate for the current year has improved by more than 100% over the last 30 days. The stock has gained more than 100% year to date.

Immersion Corp. (IMMR - Free Report) develops hardware and software technologies that enable users to interact with computers using their sense of touch.

Immersion Corp.’s expected earnings growth for the current year is more than 100%. The Zacks Consensus Estimate for the current year has improved by 51.5% over the last 60 days. The stock has gained more than 100% year to date.

Northern Oil and Gas, Inc. (NOG - Free Report) is an exploration and production company of oil and natural gas properties in the United States.

Northern Oil and Gas’s expected earnings growth for the current year is more than 100%. The Zacks Consensus Estimate for the current year has improved by 2.8% over the last 30 days. The stock has gained 56.6% year to date.

Elevate Credit, Inc. (ELVT - Free Report) offers online credit solutions to non-prime consumers in the United Kingdom and the United States.

Elevate Credit’s projected growth rate for the current year is more than 100%. The Zacks Consensus Estimate for the current year has improved by 4% over the last 30 days. The stock has gained 26.3% year to date.

Covenant Transportation Group, Inc. (CVTI - Free Report) is a truckload carrier that offers just-in-time and other premium transportation service for customers throughout the United States.

Covenant Transportation’s expected earnings growth for the current year is more than 100%. The Zacks Consensus Estimate for the current year has improved by 6.1% over the last 30 days. The stock has gained 8% year to date.