JPM JP Morgan Chase and Co

By Georgi Kantchev and Riva Gold 

J.P. Morgan is turning more cautious on small and midsize companies on a belief that President Donald Trump's stance on trade will add to heightened political risks around the world.

The bank advised its clients Thursday to buy put options, or derivatives that protect against declines, on indexes that track shares of small and midsize companies. Shares in these companies have been popular so far this year.

J.P. Morgan saw more upside potential for such stocks at the beginning of the year, assuming that Mr. Trump would focus on his campaign promises of a fiscal boost through tax cuts and infrastructure spending.

"Instead, it seems like global trade is his number one focus from the start, something which in our opinion adds downside risk to our 2017 outlook," Eduardo Lecubarri, J.P. Morgan's global head of small and midcap strategy, wrote in a note to clients Thursday. "We worry about big short-term shocks to the global economy at this stage of the game."

J.P. Morgan believes that shares of small and mid-capped companies, those with a market capitalization between $100 million and $5 billion, could still hold at around current levels for some time. But the bank warns that investors are too complacent against risks from Mr. Trump's trade policies and others, ranging from Brexit negotiations to upcoming elections in Europe.

Small and midcap U.S. stocks have been a popular bet since the election, on expectations that Mr. Trump's policies would lower taxes and boost the U.S. economy. The S&P Small Cap 600 index is up 18% in the last three months, while the S&P Mid Cap 400 is up nearly 14%, compared with a less than 9% climb for the S&P 500 over the same period.

Many investors have bet small and midsize companies are better positioned to weather harsher trade rhetoric and a stronger dollar, given their greater exposure to the domestic economy.

Such companies still have significant international exposure, the bank said.

In his first days in office, Mr. Trump's administration has formally withdrawn from the 12-nation Pacific trade agreement, known as the Trans-Pacific Partnership, restated his intention to renegotiate the North American Free Trade Agreement, or Nafta, and endorsed a new "border adjustment," which would tax businesses for their imports, though not their exports.

Mr. Trump's policy proposals come at a time when the World Trade Organization expects that global trade growth was at its weakest last year since the financial crisis. That came amid rising protectionist policies around the world and as efforts to liberalize trade stall, economists say.

There are risks to global trade on the other side of the Atlantic, too.

Legislation to allow Britain to begin its withdrawal from the European Union passed its first parliamentary hurdle on Wednesday. Economists say Brexit could raise tariffs around trade into and out of Britain, one of the world's biggest economies.

A spate of elections in the EU's biggest member states, including France and Germany, are also adding to political risks, with some opposition parties demanding withdrawal from the European Union or the eurozone.

"President Trump and U.K. Prime Minister May seem determined to rip up what the world considered established rules of engagement in global trade at a time when the world's economy is deeply invested in globalization," Mr. Lecubarri said. "But the market is turning a blind eye to risk...we find this concerning [as] 2017 is arguably the year with the biggest political risk of the last 20."

Write to Georgi Kantchev at georgi.kantchev@wsj.com and Riva Gold at riva.gold@wsj.com

(END) Dow Jones Newswires

February 02, 2017 08:00 ET (13:00 GMT)

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