How will US small-caps respond to tariffs and heightened volatility?

The announcement of tariffs by President Trump on imports from China, Canada, and Mexico has introduced uncertainty into the markets, particularly affecting short-term sentiment and volatility. While the immediate impact on earnings and business fundamentals remains unclear, the strategic use of tariffs seems aimed at addressing non-economic issues, suggesting they might be temporary. Key sectors potentially affected include housing, auto, and agriculture, though the long-term fundamentals may not be significantly altered.

The tariffs are expected to accelerate trends like deglobalization and reshoring, benefiting US manufacturing and supporting small-cap stocks. These stocks are poised to regain market leadership due to their attractive valuations and potential for earnings growth. The current environment of heightened uncertainty and volatility, driven by the new administration's policies, is seen as an opportunity for small-cap investors who can leverage these conditions for long-term gains.

Historically, periods of elevated volatility have favored small-cap equities, as evidenced by better average annualized returns for the Russell 2000 compared to the Russell 1000 during such times. This environment allows for a clearer distinction between high-quality companies and those lacking strong fundamentals. As we move into 2025, the outlook for small-cap equities remains positive, supported by a strategic, active investment approach that capitalizes on market inefficiencies and cyclical dynamics.