News & Insights

TAILWINDS COULD PRODUCE OVERDUE RETURNS FOR SMALL AND MIDCAP STOCKS

As mega-cap equities have dominated S&P 500 performance in recent years, many investment managers have continued to hold domestic small- and mid-cap (SMID) stocks in their portfolios, consistently lagging the larger benchmark. The new administration’s economic and policy shifts are signaling a potential resurgence among SMID-cap stocks. A falling interest rate environment, combined with lower corporate taxes and declining regulatory burdens, bode well for businesses, with smaller companies experiencing the greatest relief. As inflation continues to cool, the dollar strengthens, and domestic demand remains strong, this environment could have an outsize benefit for SMID caps, as the largest companies have less beneficial international revenue exposure and risks associated with lagging foreign economies.

SMID caps tend to outperform at the tail end of a bull market which characterizes our current position, being just over halfway through the 979 trading days of the average bull market. SMID caps also tend to outperform in the third year following the S&P 500 posting two consecutive years above 20% returns. In the modern market era, SMID caps have also outperformed in the first year after a change in presidential party. Cheaper historic valuations in combination with the anticipated tailwinds are likely to lift SMID cap stocks.

SMALL AND MID CAPS HAVE HAD MODEST RETURNS SINCE 2022

Source: Oxford Economics

SMALL CAPS WILL BENEFIT FROM STRONG DOMESTIC DEMAND

Source: Oxford Economics

“AMERICAN EXCEPTIONALISM” DRIVING THE STRONG DOLLAR

A rising U.S. dollar received a boost from the November election. With Republicans controlling the White House and both houses of Congress, the Trump administration is moving quickly to deliver on its campaign promises, including cutting taxes, slashing regulations and threatening new tariffs. As these changes take hold, they could potentially push the dollar even higher.

Potential tariffs targeting countries with large trade surpluses would affect China, Japan, Canada, Mexico and some European nations. Recently announced tariffs have quickly depreciated the targeted countries’ currency. Strong U.S. GDP growth provides less incentive for the Fed to lower interest rates. As many other nations struggle to produce growth and ease monetary policy, the interest rate differential spurs capital investment in the U.S., adding further value to the dollar. The anticipated effect of repatriating manufacturing is also supporting the greenback. While the 3 U.S. has embraced a free enterprise, smaller government, pro-energy, deregulatory approach, much of the rest of the developed world remains mired in political turmoil, including France, South Korea, Canada, Germany, and the U.K. Given that this is the early stage of policy tsunami, the drivers of a strong dollar are unlikely to abate.

COUNTRIES’ GDP GROWTH FOR 2024, 2025, AND 2026

Source: Goldman

US DOLLAR INDEX DXY

Source: Bloomberg

GROWTH COULD IMPROVE THROUGHOUT 2025

The Labor Department confirmed that nonfarm productivity, measuring hourly output per worker, increased by 1.2% quarter-over-quarter annualized in the fourth quarter, down from the upwardly revised 2.3% in the third quarter. Over the past year, productivity has been running at improved levels, averaging 1.8% this cycle versus 1.5% in the previous one.

The report also reflected a jump in unit labor costs of 3.0% quarter-over-quarter annualized on the back of two very modest quarters. While the rising costs do not materially change the macro-outlook, it is evidence of some upward pressure on inflation. This aligns with the Fed’s “wait and see” approach to cutting rates.

A tight labor market and the post-pandemic bout of inflation have forced companies to find ways to do more with less, which has contributed to increased investment in new equipment and technology, boosting productivity. Labor costs are still relatively high but will continue to normalize. The falling quits rate reflects lower financial incentives to move from one employer to another, which will cap labor cost growth for 2025. Capital flows into the U.S. amidst improving business sentiment and burgeoning enthusiasm around the potential of AI, will drive large increases in capital expenditures. That should further boost efficiencies for businesses.

NONFARM BUSINESS SECTOR: LABOR PRODUCTIVITY FOR ALL WORKERS

Source: Bloomberg

NONFARM BUSINESS SECTOR: UNIT LABOR COSTS FOR ALL WORKERS

Source: Bloomberg

About Frost Investment Advisors, LLC

Frost Investment Advisors, LLC, a wholly owned subsidiary of Frost Bank, one of the oldest and largest Texas-based banking organizations, offers a family of mutual funds to institutional and retail investors. The firm has offered institutional and retail shares since 2008.

Frost Investment Advisors' (FIA) family of funds provides clients with diversification by offering separate funds for equity and fixed income strategies. Registered with the SEC in January 2008, FIA manages more than $4.5 billion in mutual fund assets and provides investment advisory services to institutional and high-net-worth clients, Frost Bank, and Frost Investment Advisors’ affiliates. As of Jan. 31, 2025, the firm has $5.1 billion in assets under management, including the mutual fund assets referenced above.

Mutual fund investing involves risk, including possible loss of principal.

To determine if a fund is an appropriate investment for you, carefully consider the fund’s investment objectives, risk, charges, and expenses. There can be no assurance that the fund will achieve its stated objectives. This and other information can be found in the Class A-Shares Prospectus, Investor Shares Prospectus or Class I-Shares Prospectus, or by calling 1-877-71-FROST. Please read the prospectus carefully before investing.

Frost Investment Advisors, LLC (the "Adviser") serves as the investment adviser to the Frost mutual funds. The Frost mutual funds are distributed by SEI Investments Distribution Co. (SIDCO) which is not affiliated with Frost Investment Advisors, LLC or its affiliates. Check the background of SIDCO on FINRA's http://brokercheck.finra.org/.

Frost Investment Advisors, LLC provides services to its affiliates, Frost Wealth Advisors, Frost Brokerage Services, Inc. and Frost Investment Services, LLC. Services include market and economic commentary, recommendations for asset allocation targets and selection of securities; however, its affiliates retain the discretion to accept, modify or reject the recommendations.

Frost Wealth Advisors (FWA) is a division of Frost Bank [a bank subsidiary of Cullen/Frost Bankers Inc. (NYSE: CFR)]. Brokerage services are offered through Frost Brokerage Services, Inc., Member FINRA/SIPC, and investment advisory services are offered through Frost Investment Services, LLC, a registered investment adviser. Both companies are subsidiaries of Frost Bank.

This commentary is as of Feb. 18, 2025, for informational purposes only and is not investment advice, a solicitation, an offer to buy or sell, or a recommendation of any security to any person. Managers’ opinions, beliefs and/or thoughts are as of the date given and are subject to change without notice. The information presented in this commentary was obtained from sources and data considered to be reliable, but its accuracy and completeness is not guaranteed. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing. Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not indicators or guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification strategies do not ensure a profit and cannot protect against losses in a declining market. All indices are unmanaged, and investors cannot invest directly into an index. You should not assume that an investment in the securities or investment strategies identified was or will be profitable.

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