Tariffs: Risks and Opportunities for Small-Caps

Key Takeaways

On April 2, President Donald Trump announced extensive tariffs on almost every country worldwide to retaliate against what he claimed were decades of unfair trade practices.

Since then, the subsequent trade war has eased somewhat, as the U.S. announced a 90-day pause with most countries to negotiate trade deals. The U.S. and China have also agreed to reduce the extensive tariffs on each other’s goods temporarily.

The tariffs have significantly impacted some countries and regions, such as Europe, China and Southeast Asia, while others, like Canada and Mexico, have experienced comparatively better outcomes.

Higher tariffs tend to slow economic activity, which could negatively affect small-cap stocks due to their sensitivity to economic conditions.

This article aims to help investors understand the nuanced effects of tariffs on small-cap value stocks across various sectors.

Industrials

While much attention has been given to the adverse effects of tariffs on industrial companies, some businesses may not be affected, and others may even benefit. For instance, money transfer companies like Brinks or Loomis are unlikely to face any negative impacts. There could be a bolstered demand for moving money or valuables like gold.

But other industrial stocks might face a tough road. Bluebird, for example, manufactures school buses. It sources gas and propane engines from a Ford plant in Canada and frame rails and electronic components from Mexico. Bluebird buys most of its steel from the U.S., but tariffs on imports will increase domestic prices.

Automobiles

Autos have largely avoided the worst of the situation. The Trump administration won’t impose reciprocal tariffs on imported vehicles. Canada and Mexico are exempt from reciprocal tariffs, which offers some hope that negotiations could still occur among North American trading partners.

For auto suppliers, parts that comply with the U.S.-Mexico-Canada Agreement (USMCA) remain exempt from tariffs, although it’s unclear whether this exemption will be permanent. Original equipment manufacturers, or OEMs, received some relief, as U.S.-made cars will get a reimbursement of 3.75% of the manufacturer’s suggested retail price (MSRP) for tariffs paid on non-U.S. content.¹ However, consumer prices will likely increase, leading to lower demand and production.

For example, about half of the products made by Sensata Technologies, a manufacturer of sensors and electrical components, comply with the USMCA. However, products with more electronic components, like semiconductors, may not meet compliance requirements. The company has manufacturing capacity in the U.S., so it could shift some production from Mexico.

Residential Real Estate

Tariffs may lead to slight cost increases for homebuilders, but these costs could be absorbed at various stages of the construction process without being fully passed on to homebuyers. A more significant challenge would arise if higher prices for everyday items and general economic uncertainty cause consumers to postpone home purchases. The Federal Reserve is cautious about lowering interest rates due to inflation concerns, meaning homebuilders must continue to handle higher mortgage rates.

Consumer Staples

We believe companies in this less cyclical sector should perform better during the current economic turbulence. Consumers still typically buy these firms’ essential products regardless of economic conditions. However, tariffs could have unique effects on these companies.

For example, Spectrum Brands wants to sell its home appliances business to focus on lawn and garden and pet products. Tariffs on the imported parts and materials (e.g., electronics, steel, aluminum) needed to produce appliances are changing the math on the company’s efforts to sell the business.

Specialty Retail

Many clothing brands have moved production to Southeast Asia, shifting from China to countries like India, Vietnam and Cambodia, which are experiencing higher tariffs.

Capri Holdings, a luxury fashion company, faces challenges from tariffs because of its manufacturing presence in Southeast Asia. At the same time, the company is working on revitalizing its brand amid a slowdown in consumer spending. The company recently sold its iconic Versace brand to Prada, providing Capri with essential cash as it navigates a challenging market.

Although tariffs don’t directly affect boat dealers, if boat OEMs increase prices to cover higher input costs, these increases would be passed on to consumers.

Most buyers finance their boats, so a 3% to 5% increase on a $200,000 boat might not feel like a big deal over a 20-year loan. The boat industry is typically responsive to public sentiment, meaning that any negative feelings over a price increase could still have an impact.

Energy

Tariffs won’t directly impact energy, but energy demand may decline if trade barriers impede the U.S. economy. Following the tariff announcements, crude oil prices fell, indicating expectations of an economic slowdown in energy consumption. For context, the sell-off on April 3 caused crude prices to fall back to levels not seen since two weeks earlier.

Our optimism for small-cap energy stocks is twofold. Stocks in the sector are cheap, and the companies have better balance sheets than they did years ago. Many small-cap energy companies have hedged future production at higher levels, which may help protect margins even if crude prices continue to fall.

Health Care

Less-volatile stocks in the health care sector include some of the higher-quality businesses with more stable earnings, such as medical device manufacturers, which commonly obtain materials from abroad. Are these imported materials subject to tariffs?

Enovis™, which makes orthopedic braces and joint replacement components, imports materials from a textile factory in Mexico. About 90% of the materials manufactured at this facility are exempt from tariffs under the USMCA. However, tariffs on steel and aluminum will affect the company’s implants business. The company expects the net cost of tariffs to be slightly less than its previous estimate of $3 million to $4 million monthly.

Health care companies may be exempt from tariffs in other ways. For example, Embecta™, a manufacturer of insulin delivery products for people who have diabetes, produces a pen needle in Europe that’s sold in the U.S. The company’s products qualify for tariff exemptions under the Nairobi Protocol, an international agreement that exempts a limited range of medical products intended for use by individuals who have disabilities.

Products for treating sleep apnea were exempt from tariffs in the past. Sleep apnea equipment manufacturer ResMed recently confirmed its exemption status under the current tariff policy with U.S. Customs and Border Protection.

Real Estate Investment Trusts

We believe real estate investment trusts (REITs) are among the best-positioned sectors to weather tariffs, although trade policies can have distinct effects on specific subsectors. Lodging and retail REITs, for example, may face headwinds if higher prices reduce consumer spending on travel.

Industrial REITs could experience lower demand at ports but also benefit from reshoring. Health care and other triple-net REITs are likely the most insulated from tariffs, as their longer-term leases typically provide a layer of security to these subsectors.²

Uncovering Small-Cap Value Opportunities Amid Tariff Uncertainty

Small-cap stocks have sold off since last November and are currently among the cheapest asset classes.

Tariffs affect sectors and companies in different ways. As active small-cap value managers, we believe this creates an opportunity for us to identify high-quality securities less affected by global trade policies.