SMID cap stocks did well throughout most of 2016, especially small cap stocks, but then came December, and this group flip-flopped to underperform the market. Does this mean that more underperformance is ahead for SMID cap stocks, or can the group return to a strong performance for most of this year?

The answer may lie in what happens to the world’s currencies, taxes and trade, and much is expected to change in at least of these two areas in the U.S., if not all three, under Donald Trump.

SMID cap stocks beat in 2016, weakened last month

In a research note dated Jan. 9, Morgan Stanley equity strategist Adam Parker made the case for SMID cap stocks for this year. For most of 2016, smaller was better, and Parker still likes small caps over large (the 51st through 300th biggest U.S. stocks) and mega caps (the 50 biggest U.S. stocks) despite their December underperformance.

SMID cap stocks

He noted that small cap stocks outperformed the broader market by 6.2% in 2016, while mid caps beat the market by 0.87%. In December, however, SMID cap stocks underperformed large and mega caps by 1.1%, with underperformance noted in seven of the 11 sectors.

December brought the best performance in low beta, value and low quality stocks within the group.

SMID cap stocks hang on currencies taxes, trade

Parker prefers SMID cap stocks over large and mega caps due to currency, taxes and trade, although he feels that these factors have been priced in somewhat. Despite this, he still feels that the valuation compared to the group’s recent history is “compelling.”

The strategist also made a case for his three-month alpha model, which he calls MOST, and his 24-month alpha model, which he calls BEST. He said both quant models did well last year, with three of the five greatest monthly returns since these quant models were started occurred last year. He said the highest return came in January at 7.15%, while the second highest was in October at 6.19%. The fourth highest was in August at 5.29%.

In fact, when applying the models to SMID cap stocks, they posted positive returns nine months of the year. They also posted positive returns in the last five months of last year.

The quant models’ cumulative return for last year was 31.52%.