The impact of Trump 2.0 on US smaller companies so far…

As we entered 2025, investors optimism was high with the election of Donald Trump as president and the view that his policies would be supportive to markets. We are now just beyond a month into his presidency and there are, undoubtedly, signs that things are not going as smoothly as people had predicted. The sheer volume of announcements coming from President Trump and his cabinet is distracting. While we know the business community values the prospect of reduced regulation and taxation, all the rhetoric concerning tariffs and – to a lesser extent – immigration, give pause for thought.

In addition, inflation has been a little stickier than we would have hoped, although the positive dynamics of falling rental inflation and an acceptable level of wage inflation argue for a hiatus in interest rate cuts rather than a reversal.

There are also questions in the minds of some investors about investment in AI, which had been one of the key drivers of the equity market.

Has our view on US smaller companies changed?

We, like others, were too optimistic on the initial Trump impact, over-interpreting significant jumps in business confidence supported by strong anecdotal evidence from regional banks into a more immediate jump in economic activity. That being said, we still believe that the combination of deregulation, lower taxes and a consumer and corporate sector in rude health will support economic growth. We do not believe the AI theme has peaked, but rather that it will continue to be a driver of investment in the US.

We would also make the following broader observations, which support our positive view on US smaller companies:

Attractive valuations

Over recent years, smaller companies have significantly derated. Smaller companies’ valuations are now at multi-decade lows relative to larger companies.

Small-cap stocks forward P/E ratio relative to large-cap stocks

It is important to note that this low valuation is not necessarily a reflection of lower quality. The Russell 2000 has a very large component of unprofitable businesses – around 40% of the index. Yet the valuation discount is particularly marked for profitable smaller companies – the higher-quality area on which we focus. This means we are finding many high-quality businesses trading at very attractive valuations either to large-cap stocks or to their own long-term averages. With earnings growth accelerating and business optimism building, we would expect this valuation gap to narrow.

Positive earnings outlook

After a period of weakness, earnings growth for smaller companies started to improve in 2024 and is poised to accelerate in 2025.

Smaller companies struggled during the two-year interest rate hiking cycle, which raised their debt financing costs. Fears of a US recession also weighed on performance. Coming into 2025, the macro-economic backdrop now looks much more attractive. US growth appears to be resilient, inflation has eased and interest rates are on a downward path. All of this is lending support to smaller companies’ earnings, particularly as they tend to have a domestic focus. Unlike the S&P500, which is dominated by global companies with international revenues, the Russell 2000 derives the majority of its revenues (almost 80%) from the home market.

Taking advantage of lower valuations

With our positive view on the outlook for US smaller companies, we take the view that any setback in the market makes the opportunities we have already identified for the next one or two years suddenly become more attractive investments. We continue to exercise discipline and analytical rigour in identifying the best investments for our portfolio. We are confident that we already own a number of these and suspect over the next month or so that we will be making some of them bigger positions in our portfolio.