Hello, and welcome to another adventurous week in the markets. Last week certainly lived up to the “new normal” we are adjusting to as daily headlines drive market action. But it seemed a little calmer than the week before. Maybe that’s just the psychology of coming off big surprise down week the week prior, or maybe the inflation data coming in a little cooler than expected last week helped a little too. That said, we still saw losses across all major indices for the second week in a row.

Speaking of which, last week the Dow was down 3%, the S&P 500 was down 2% and the tech- heavy NASDAQ was down 2%. That was on top of the losses we saw the week prior: Dow down 2%, S&P 500 down 3% and NASDAQ down 3%. So, the markets have certainly been taking it on the chin lately.

This sell-off has been primarily driven by none other than increased volatility in the markets. Which we can clearly see on both the VIX and MOVE indices that have been trending up since the end of February. Each measures the general level of volatility across the equity and bond markets (i.e. uncertainty). Please see the disclosures below for definitions of the VIX and MOVE indices. 

This added volatility can simply be attributed to heightened uncertainty around trade and tariffs as new announcements from the Trump administration come out pretty much every day. We should continue to expect more of the same in the coming weeks, as new tariffs come out and foreign countries respond (200% on European wine for example). This will likely keep volatility elevated.

April 2 is a key date too, because that is the day President Trump has set to implement a new wave of tariffs (on autos for example), along with reciprocal tariffs (a match on what other countries are charging US imports). But in the days leading up to April 2, we should also expect more tariff announcements which will cause more volatility. And if Trump stays aggressive as he has been, we may see further downside pressure in the markets. However, if we see some easing or at least no new news on tariffs, that could provide some relief.

All this said, we are indeed in a new environment where tariffs are here to stay. So, as investors, we need to think about how to position ourselves around this reality and any new potential surprises that may come up with tariffs.

One idea to consider when you think about tariffs is small caps. Here are a few compelling reasons why that may be an interesting idea right now:

1. Small Caps Primarily do Business in the United States.

Small cap companies primarily do business within the United States. So, all else equal, small caps are not exposed to tariffs as much as their larger counterparts. Who typically do business overseas.

2. If Foreign Imports Stopped, Small Caps May Not Be Hurt as Much.

Thought of another way: if foreign companies simply stop doing business with the United States (like they are doing in Canada by taking US liquor off the shelves), OR people in the US just stop buying foreign product, then, generally, small cap companies may fare better. Because small cap companies typically do business in the United States and sell “homegrown product”. Now, of course not all international trade will come to a halt, but there could be an imbalance that favors small caps if tariffs slow international business with the United States. Furthermore, if countries outside the US retaliate with reciprocal tariffs, that also means more products may sold at home. Which could further benefit small caps.

3. Small Caps Tend to do Better in a Declining Interest Rate Environment.

Consider the Fed and rates. I think we can all agree that we are eventually heading into a lower interest rate environment. How and when is up for debate, but it is certainly just a matter of time. Couple that with a possible slowing here from some of the headwinds we have been seeing lately (consumer confidence down, Atlanta Fed GDP in the red), and we might see lower rates coming from the Fed sooner rather than later.

To that end, one common theme here is the cost of borrowing. That is, when rates go down, the cost of borrowing goes down too. And with small caps, they tend to have more loans on books (because they tend to borrow more to fund their operations) so generally, their borrowing costs go down more. Which in turn helps drive profitability. And ultimately higher valuations for small caps in the market.

4. Small Caps Have Scalable Growth Potential.

Small cap companies tend to operate in niches with less competition. This enables them to scale an idea relatively quickly to a competitively advantaged and sustainable business. This also helps drive growth and ultimately deliver value. Which, if successful, translates to potentially favorable fundamentals. Such as strong balance sheets, consistent revenue and earnings growth (even if the company isn’t profitable to start), high gross margins, strong return on invested capital, and consistent positive or improving free cash flow. For investors, this is an opportunity.

As an example, think of a company that sets a growth goal of 10%. For a smaller company at, say, $2B market cap they would only need $200 million in sales to achieve 10% growth. But a larger company, say, $200B would need $20B in sales to achieve the same 10% growth rate. That’s quite a bit more production to achieve that same growth rate. This simply shows how small caps could possibility have the edge on growth as an early-stage company, versus late stage/mature companies.

5. Small Caps are Cheap Right Now.

Current valuation metrics show small caps are trading at a discount to the broad market. Such as Morningstar’s price to fair value analysis for the space (see screen shot below from Morningstar)

Source: Morningstar

Combine this with the fact that small caps have underperformed the broader market for over a decade now and this points to a compelling opportunity for small caps right now. See the charts below which show BLUE for the S&P 500 Large Cap Index, PINK for the S&P 600 Small Cap Index, and GREEN for the Russell 2000 Small Cap Index, since 2014:

Source: Yahoo Finance

They are even down this year, almost 10%, which you can also see in this chart (as of 3/17/25 close). BLUE for the S&P 500 Large Cap Index, PINK for the S&P 600 Small Cap Index, and GREEN for the Russell 2000 Small Cap Index:

Source: Yahoo Finance

One final thing to consider on valuations. If you lengthen the timeframe out to 15 years, you can see a “premium” that was in effect for small caps going all the way back that far. This is evident by the PINK (S&P 600) and BLUE (Russell 2000) lines trading above the BLUE line (the S&P 500). But, over time, that premium slowly faded and is now gone, essentially considered as a discount now. But it paints a compelling picture that it may possibly come back. Or at least begin to trend up.

Source: Yahoo Finance

This all paints an interesting picture for small cap stocks right now.

So, could this finally be the year for small caps? We think so. Especially as tariffs work their way into the system.

We have been talking about this idea and will be shifting exposure from large to small cap in the models by the end of first quarter. This is what we always try to do with your investments; to navigate around potential risks and settle in a place that makes sense given the current market environment. All at the same time keeping you invested and most importantly, diversified.

Thank you!

Lee

Lee R. Johnson, Jr., CFA, MBA
Chief Investment Officer
Professional Planning Associates, Inc.

190 North Independence Mall West, Suite 602
Philadelphia, PA 19106

www.proplanners.org

Founder and Owner
Valor Asset Management^TM

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_Disclosures

1. _{The VIX Index is the first benchmark index to measure the market’s expectation of future volatility. It is based on options of the S&P 500® Index, considered the leading indicator of the broad U.S. stock market. The VIX Index is recognized as the world’s premier gauge of U.S. equity market volatility.}
2. _{The Merrill Lynch Option Volatility Estimate (MOVE) Index reflects the level of volatility in U.S. Treasury futures. The index is considered a proxy for term premiums of U.S. Treasury bonds (i.e., the yield spread between long-term and short-term bonds).}
3. _{Small Cap stocks are typically defined as those with a market capitalization ranging from $300 million to $2 billion. The market capitalization denotes the fair market value of the outstanding shares of any company that trades on a stock exchange. However, a company’s market capitalization will constantly change due to the fluctuations in the share price.}
4. _{A diversified portfolio does not assure a profit or protect against loss in a declining market. Investors cannot invest directly in indexes.}
5. _{The performance of any index is not indicative of the performance of any investment and does not take into account the effects of inflation and the fees and expenses associated with investing.}
6. _{Small-cap funds may be subject to a higher degree of market risk than large-cap funds or more established companies' securities. Furthermore, the illiquidity of the small-cap market may adversely affect the value of an investment so that shares, when redeemed, may be worth more or less than their original cost.}
7. _{The views stated in this letter are not necessarily the opinion of Cetera Advisors LLC and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein.}
8. _{Due to volatility within the markets mentioned, opinions are subject to change without notice.}
9. _{Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed.}
10. _{Past performance does not guarantee future results.} 
11. _{Rebalancing a portfolio may cause investors to incur tax liabilities and/or transaction costs and does not assure a profit or protect against a loss.}
12. _{The prices of small and mid-cap stocks are generally more volatile than large cap stocks.}
13. _{International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. These risks are often heightened for investments in emerging markets.}
14. _{Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price. The market value of corporate bonds will fluctuate, and if the bond is sold prior to maturity, the investor’s yield may differ from the advertised yield. Bond yields are subject to change. Certain call or special redemption features may exist which could impact yield. Investment grade bonds are those graded BBB and above. Preferred stocks are "hybrid" investments, sharing characteristics of both stocks and bonds. Like a stock they are generally paid after a bond, but like a bond they offer a fixed rate of payment and par value upon maturity/redemption. Risks can include interest rate risk, longer duration, lower credit ratings, and sector concentration, etc. Convertible bonds are a type of debt security that can be converted to a fixed number of shares of the issuer’s common stock.}
15. _{The fast price swings in commodities and currencies will result in significant volatility in an investor’s holdings. Precious metal investing involves greater fluctuation and potential for losses.}
16. _{The payment of dividends is not guaranteed. Companies may reduce or eliminate the payment of dividends at any given time.}
17. _{Dividend yield refers to a stock's annual dividend payments to shareholders, expressed as a percentage of the stock's current price.}
18. _{An investment in Exchange Traded Funds (ETF), structured as a mutual fund or unit investment trust, involves the risk of losing money and should be considered as part of an overall program, not a complete investment program. An investment in ETFs involves additional risks such}
19. _{Investors should consider the investment objectives, risks, charges and expenses of the investment company carefully before investing. The prospectus and, if available, the summary prospectus contain this and other important information about the investment company. You can obtain a prospectus and summary prospectus from your financial representative. Read carefully before investing.}
20. _{Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. Value will fluctuate with market conditions and investments/portfolios may not achieve its investment objective. No strategy assures success or protects against loss. Investing involves risk including loss of principal.}
21. _{Consult your financial advisor prior to making any investment decision.}
22. _{Because of their narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies.}
23. _{The example referenced on page 2 is hypothetical only, and does not represent the actual performance of any particular investments. Investments in securities do not offer a fixed rate of return. Principal, yield and/or share price will fluctuate with changes in market conditions and when sold or redeemed, you may receive more or less than originally invested.}

_{Benchmark Definitions}

1. _{Russell 1000 Growth - The index measures the performance of the large-cap growth segment of the US equity securities. It includes the Russell 1000 index companies with higher price-to-book ratios and higher forecasted growth values. It is market-capitalization weighted. Russell Investment Group is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Russell Investment Group.}
2. _{Russell 1000 Value - The index measures the performance of the large-cap value segment of the US equity securities. It includes the Russell 1000 index companies with lower price-to-book ratios and lower expected growth values. It is market-capitalization weighted. Russell Investment Group is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Russell Investment Group.}
3. _{Russell 2000 - The index measures the performance of the small-cap segment of the US equity universe. It is a subset of the Russell 3000 and includes approximately 2000 of the smallest securities based on a combination of their market cap and current index membership. Russell Investment Group is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Russell Investment Group.}
4. _{Russell Mid Cap - The index measures the performance of the mid-cap segment of the US equity universe. It is a subset of Russell 1000 index and includes approximately 800 of the smallest securities based on a}
   1. _{combination of their market cap and current index membership. The index represents approximately 31% of the total market capitalization of the Russell 1000 companies.}
5. _{Russell 1000 - The index measures the performance of the large-cap segment of the US equity securities. It is a subset of the Russell 3000 index and includes approximately 1000 of the largest securities based on a combination of their market cap and current index membership.}
6. _{CBOE Volatility Index (VIX) - Created by the Chicago Board Options Exchange (CBOE), the Volatility Index, or VIX, is a real-time market index that represents the market's expectation of 30- day forward-looking volatility.}
7. _{CBOE Vix Volatility Index (VVIX) - The CBOE's VVIX measures the volatility of the price of the VIX. In other words, VVIX is a measure of the volatility of the S&P 500 index and alludes to how quickly market sentiment changes.}
8. _{S&P 500 - A market capitalization-weighted index established by S&P Global ratings. It is composed of the 500 most widely held stocks whose assets and/or revenues are based in the US; it's often used as a proxy for the U.S. stock market. TR (Total Return) indexes include daily reinvestment of dividends. The constituents displayed for this index are from the following proxy: iShares Core S&P 500 ETF.}
9. _{S&P 600 - A market capitalization-weighted index established by S&P Global Ratings. It covers roughly the small-cap range of American stocks, using a capitalization-weighted index. To be included in the index, a stock must have a total market capitalization that ranges from $1 billion to $7.4 billion.}