US smaller companies: looking through the volatility

President Trump’s imposition of tariffs and his refusal to dismiss the possibility of a recession have unsettled investors and made the notion of a ‘Trump put’ a serious possibility. The near-term outlook for US smaller companies has undoubtedly become more uncertain, fuelling an aggressive sell-off in the US, particularly for smaller companies, which are perceived as more sensitive to these worsening conditions.

In this piece, we ask Cormac Weldon and Olivia Micklem, managers of the Artemis US Smaller Companies strategy, for their views on recent events and what actions they are taking in the portfolio:

Has your outlook for US equities changed?

The outlook has certainly become more uncertain, as it has become clear that President Trump is willing to let equity markets and the broader economy endure some short-term pain while he pursues his radical agenda. It is not our central expectation that the US will enter a recession, but the likelihood has increased because of trade policy risks. The economy continues to benefit from strong productivity, real expansion in household income and potential pro-growth policies.

Nevertheless, the impact of tariffs is expected to be significant. The average US tariff rate is now projected to rise by 10 percentage points. These measures will weigh on growth through higher consumer prices, tighter financial conditions, and delayed business investment. With weaker growth projections, the Fed is still expected to cut rates twice in 2025, in June and December.

While recession risks have increased, it is difficult to predict the direction that President Trump will take. Will market forces check his actions? Will declining popularity influence his decisions? At the time of writing, although there are increased risks on the horizon, the economy is not in poor condition. We will proceed accordingly.

Have you made any changes to the portfolio as a result?

Yes. We have increased holdings in defensive equities and reduced exposure to companies more vulnerable to an economic slowdown.

In the first category, we have increased investments in specialist insurers Palomar and Kinsale, and discount retailer Burlington Stores. Additionally, we have bolstered our holding in Planet Fitness, where new management has reinvigorated the business model. We also invested in business services companies CBIZ and Korn Ferry, which are showing better earnings and growth prospects.

We have reduced some of our infrastructure and housing-related exposure given their economic sensitivity and uncertainty about government-funded infrastructure spending. We sold a relatively new position in Herc as the company had added significant debt to its balance sheet after acquiring a smaller competitor.

We also trimmed positions in Eagle Materials, Construction Partners, and Saia. Within the housing sector, we reduced our holding in Builders FirstSource. We also cut exposure to cyclical consumer stocks by selling our holding in SharkNinja and reducing Churchill Downs.

Regarding defensive holdings, we added a real estate investment trust, First Industrial, and a utility.

Is the market volatility creating opportunities?

There are parts of the portfolio where share prices have fallen significantly, presenting compelling risk-reward opportunities. We are evaluating whether our upside potential remains viable and have increased positions where appropriate.

We are carrying slightly higher cash than normal at approximately 4%, giving us the flexibility to seize opportunities as they arise.

During periods of high macro uncertainty, our focus on higher returning companies offers little short-term protection, as recently experienced. The market tends to be highly sceptical of all companies' prospects, treating those with strong fundamentals harshly. However, over time, such companies will demonstrate their strengths.

Simultaneously, we are monitoring 'value' stocks, recognizing that while many may be value traps, good businesses are sometimes unfairly punished by the market.

Do you still see opportunities in US smaller companies given the heightened macro uncertainty?

To balance near-term headwinds, we must remain focused on medium- to long-term opportunities within the small-cap space. We continue to see companies reporting earnings above expectations while being penalized for operating in sectors deemed unfavourable in the current environment. Deregulation and tax cuts may offset some tariff impacts.

Smaller companies entered this period of uncertainty with historically low valuations relative to larger companies, enhancing their upside when conditions improve. Burlington is one example. As a discount retailer, Burlington should benefit from macro and consumer uncertainties. The company recently reported promising results, yet the stock is down almost 20% — an unwarranted reaction, in our view.

Companies in the AI supply chain are another area of unwarranted weaknesses. Examples include Coherent, Comfort Systems, and Indie Semiconductor. Coherent supplies high-speed network cabling crucial for datacentre infrastructure. Comfort Systems provides skilled labour and modular datacentre construction. Indie Semiconductor develops advanced semiconductor solutions for automotive and industrial sectors. These companies have seen share price declines of roughly 30%, despite significant increases in AI datacentre budgets.

While confident in many holdings, we acknowledge the market is currently ‘shooting first and asking questions later’. Determining when sentiment will shift and longer-term perspectives will prevail remains challenging but we are confident that these dislocations will provide opportunities.