These are challenging days. The U.S. is experiencing a growth shock—with unemployment moving up while inflation remains stubborn, driven most recently by steeper energy prices resulting from the war in Iran and across much of the Middle East.

These difficulties are joined by other issues that have arisen over the last few weeks, including another round of tariff uncertainty, selloffs driven by frustrated AI expectations, and the Fed reportedly considering a more hawkish approach to rates in the face of sticky inflation. These developments are creating increased market volatility. To be sure, the year is a little more than two months old yet has already reminded us of how shock-prone the global environment can become—with alarming speed.

Despite these issues, small-caps continue to perform well so far in 2026, leading the market and so far coping well, more than holding their own as the market looks for more solid footing. In fact, we have been struck by the resilience of both small- and micro-cap stocks as the selling that accompanied the military strikes in Iran and other Mid-East regions saw these asset classes fall at roughly the same rates as their larger peers, with the result that smaller companies have held on to market leadership going back to last April’s market low.

Small- and Micro-Caps in the Lead
Russell Index Returns, 4/8/25-3/6/26

Past performance is no guarantee of future results.

While we find this nascent leadership highly encouraging, we also understand that the current climate is fraught with apprehension. Investors are clearly worried—and with good reason in that the world is currently awash with the kind of dangers and difficulties that often lead us to question or reassess our investment decisions.

While we find this nascent leadership highly encouraging, we also understand that the current climate is fraught with apprehension. Investors are clearly worried—and with good reason in that the world is currently awash with the kind of dangers and difficulties that often lead us to question or reassess our investment decisions.

At the same time, history suggests that geopolitical shocks are frequently sharp but often temporary and can create compelling entry points for investment, especially in high-quality businesses with durable earnings. Importantly, small-caps have also tended to lead in the recoveries that followed prior geopolitical shocks—and we believe this time will be no different. The challenge, of course, is to remain disciplined. Our investment teams all seek to use volatility to our advantage and to manage risk without losing sight of long-term opportunity.

With geopolitical events increasingly gaining space in the investment landscape, we think it’s important to remember that not every episode leads to a lasting market impairment. More often, markets experience short, pronounced drawdowns followed by recovery, even if the path appears uneven. Over time, financial and operational fundamentals—earnings growth, returns on capital, skilled management, and valuation—tend to carry more weight than near-term headlines. Every crisis is different, of course, but we take a measure of comfort knowing that as of this writing, economic fundamentals in the U.S. remain strong.

On a more granular level, we see the core pillars of accelerating earnings growth and compelling relative valuations continue to support small cap’s market leadership. We have already seen a shift in the performance dynamic within small-cap—one that is consistent with previous small-cap leadership cycles: higher quality small-caps—those with discernible competitive advantages, high and consistent returns on invested capital, and sustainable franchises—and small-cap value have reasserted leadership so far in 2026.

Our investment playbook has not changed. We remain focused on fundamentals and seek to use periods of volatility opportunistically to build positions in high-quality small-cap businesses with long runways for growth. Whether uncertainty subsides or reemerges in another form, our discipline, process, and long-term time horizon remain constant. Finally, we think that periods like the present reinforce the value of active management, as heightened volatility typically increases dispersion beneath the surface, making careful security selection all the more impactful for the days ahead. In fact, active small-cap management has an impressive track record during periods of higher volatility, as shown in the chart below.

Is Higher Volatility Good for Active Management?
Percentage Active¹ Beat Russell 2000 Within Volatility Levels, Monthly Rolling 5-Year Average Annual Return Periods 12/31/78 through 12/31/25

¹“Active” is represented by Morningstar’s U.S. Small Blend Fund. There were 568 U.S. Small Blend Funds tracked by Morningstar with at least five years of performance history as of 12/31/25.
Past performance is no guarantee of future results. Standard deviation is a statistical measure within which a client account’s total returns have varied over time. The greater the standard deviation, the greater a portfolio’s volatility.
Source: Morningstar

Investing or staying invested during tumultuous times is not always easy—but we have learned how important it can be when trying to achieve strong absolute and relative returns over the long run. Discipline and consistency of approach matter even more during periods like the present.

Stay tuned…

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