With the US president, Donald Trump, introducing sweeping trading tariffs, the globalisation of the international trading system is in danger of reversing. Trump’s trade agenda and other countries’ retaliatory tariffs are accelerating the split of the world economy into two blocs: one around China, the economic challenger; and the other around the United States.
This could, to a degree, be seen as a result of rising populism. Voters in many developed economies are in the middle of a cost of living crisis, which they blame in part on the shift to overseas low-cost manufacturing and the hollowing out of domestic economies. This is why the US administration wants to bring manufacturing back home, and the potential for inflation to return to the higher levels seen in the 20th century.
For investors this is a confusing new world, but one that over the longer term logically – and somewhat counter-intuitively – could suit smaller company stocks. Today, many smaller companies come from ‘old economy’ sectors like industrials, materials and energy that tend to do well in inflationary times. What’s more, such businesses are currently trading at much lower valuations than larger companies, and not discounting high growth years into the future. By contrast, current large cap stocks are in ‘growth’ sectors like technology and communication services, which tend to do less well when inflation and interest rates are relatively high.
The shorter term is likely to be uncertain and volatile, with an economic slowdown a distinct possibility. However, once the dust settles the relative investment merits of smaller companies could start to become clear.
The American author Mark Twain is reputed to have said that history doesn’t repeat itself but it often rhymes. In similar cycles over the past 250 years, notably the 1930s, economic struggles have often sparked populism and trade friction, accompanied by war and inflation (Figure 1).
Figure 1: A 250-year cycle – depression-populism-wars/fiscal-commodity reflation
US commodity index since 1795 with major deflationary depression lows (blue dots)
Source: US census – historical statistics of the US (1795-1904) / US Federal Reserve – Industrial Commodities (1904-1956) / FTSE/CRB indices (1956-1994) and Stifel (1994 onwards). Shown as 10-year rolling compound annualised growth rate, monthly data
During the 1930s, however, small cap stocks performed extremely well. They also outperformed in the ‘stagflationary’ period of the 1970s. Arguably, today’s environment is similar to the 1930s, even if the difficulties do not appear so severe. The global financial crisis of 2008-2009 has been followed a decade or so later by the emergence of populism and a trade war. Meanwhile, a real war is raging in Ukraine and the Middle East, with tensions also high between China and Taiwan (Figure 2).
Figure 2: Upward trends?
Commodity index (LH Y axis in blue) versus Large cap value relative to Growth (RH Y axis in red) If commodities rise at CAGR 5%-6% we expect value beats growth1
Source: As of June 2025. US Federal Reserve – Industrial Commodities (1904-1956) / FTSE / CRB indices (1956-1994) and Stifel (1994 onwards). Total return (price + dividends reinvested) for Value / Growth data begins July 1926, as such a 10-year CAGR begins July 1936. 1Large cap value relative to Growth is Ken French data 1926-1978, all other data Bloomberg terminal data 1978 onwards / Stifel estimates. All data as 10-year rolling compound annualised growth rates.
Commodity index (LH Y axis in blue) versus Small Cap relative to Large cap (RH Y axis in green). If commodities rise at CAGR 5%-6% we expect small-cap beats large cap.
Sources: Source: As of June 2025. US Federal Reserve – Industrial Commodities (1904-1956) / FTSE/CRB indices (1956-1994) and Stifel (1994 onwards). All data as 10-year rolling compound annualised growth rates.
Logically suited to a new world
So, why might smaller companies perform relatively well at such a time? In addition to their value, old economy characteristics, smaller companies trade largely within their own countries, relying less on international sales. As government policies seek to stimulate national economies, for instance through rising defence spending, smaller companies are more likely beneficiaries than larger ones.
If there is high inflation, an advantage that higher quality smaller companies have is that they are nimble and are able to adjust quickly. With a focus on more niche markets, they are often dominant players and able to pass higher costs on to customers. This helps them maintain profitability better than more bureaucratic, slower moving larger companies that may have complicated global supply chains.
Thinking of the types of companies that do well in a higher inflation world, it is useful to examine the different compositions of the large and small cap stock market universes. More than a third (37%) of the MSCI ACWI Large Cap Index is in technology and communication services stocks, with only 15% in industrials, materials and energy. But the MSCI ACWI Small Cap Index is almost its mirror image: it has just 16% in technology and communications services and 31% in industrials, materials and energy.
In other words, small cap stocks operate in exactly the right business areas for a higher inflation world, and large cap stocks are in the wrong ones.
Actively steering the fund
Such volatile times are suited to professional investment managers who actively steer portfolios towards the stocks likely to perform well. If the world is characterised by geopolitical tension, higher inflation, elevated interest rates and labour claiming a greater share of the economy, then one approach investors might adopt is to own superior companies with pricing power and robust finances, ie, local businesses that don’t have much of their cost base in the form of labour. They should also be sensitive to valuations, given the prospect of higher interest rates than we have been used to.
For that reason, the Global Smaller Companies Trust only has 10% of its assets in technology and communications services stocks –less than the 16% in the MSCI ACWI Small Cap Index. It is also very overweight in industrials and materials, with 38% of the fund dedicated to those sectors, compared with 27% for the index.
These choices are also reflected in its regional allocations. Just 45% of the trust is invested in North American companies, less than the MSCI index’s 60%, as a lot of them are technology and so-called ‘long duration’ stocks. Instead, the trust is tilted towards the more value and out-of-favour markets like the UK (20%) and Europe (10%).
Examples of individual companies owned by the trust include diversified industrial companies such as Bodycote and MSC Industrial Direct. In defence, we own Chemring and Curtiss Wright, and in construction materials we own Breedon Group and Martin Marietta Materials. In such confusing times, logic tells us that higher quality smaller companies such as these are likely to have relatively robust prospects.
One can never be certain, but smaller companies appear to be on the right side of history.
