Macroeconomic Conditions That Could Support U.S. Small Caps
There are other macroeconomic factors that bode well for U.S. equity investors, too. Thanks to restrained spending during the pandemic, many U.S. consumers have pretty healthy savings right now. This could help support consumption and growth even in the face of inflation, geopolitical instability and lower GDP forecasts. 

Though we’ve revised our growth forecasts lower in light of the war in Ukraine and its myriad ripple effects, we still hold a positive outlook for the US economy as well as US small caps (Table 4). This asset class tends to be a domestically oriented, so it could benefit from even a modest uptick in U.S. growth.

We also think that in spite of inflation, services are likely to keep bouncing back as Covid restrictions ease throughout the country. The likely beneficiaries of this shift are better represented among U.S. small caps than large.

Geopolitical risks with Russia, China and elsewhere may continue and increase in the coming months and years. It’s possible that globalization as we’ve known it in the 21st century has peaked in the U.S. If this is the case, U.S. companies may look to invest domestically in areas including manufacturing and supply chains. This means that U.S. smaller companies that fall along these supply chains or in these areas of manufacturing could benefit. This is especially true considering that we still expect capital spending to be strong in the coming years.

Quality: The Key Consideration In Small-Cap Investing?
Fundamentals remain strong for U.S. small caps. As do relative valuations. In fact, the valuation of small caps relative to large caps remains historically low.

And, as we’ve said before, we believe that there are often small-cap opportunities to be found, regardless of market environment, for investors who focus on quality. There are several important considerations when it comes to evaluating the quality of a company.

One is pricing power. Firms with pricing power are more likely to better handle rising input costs and avoid negative impacts on operating margins. Higher barriers to entry and elevated switching costs are two indicators of pricing power. A third is whether a given small company offers differentiated products and services.