A variety of factors drove adverse market sentiment. The speed and magnitude of interest rate rises were chief among them. Market participants punished longer-duration assets at any hint that rates would remain ‘higher for longer’. Quality and growth stocks sold-off in response. But this dynamic has changed. Developed economies are slowing. Inflation is largely under control. And most central banks have reached the end of their rate-tightening cycles. The next moves will be lower, although the timing and magnitude remain uncertain. Historically, small- and mid-caps outperform larger companies when central banks start reducing rates (see Chart 1). True, this chart relates to the US, but we think there’s enough read across to other small-cap geographies to make similar assumptions about performance.

We expect quality and growth to do well in a slowdown. Investors should start to differentiate between companies with strong balance sheets and those weaker names that need to refinance at higher rates or tap shareholders for more equity. Those quality small caps with operating momentum, defendable competitive advantages and access to capital should do well. This includes firms that can grow independently of the external environment, through structural drivers and management initiatives. Finally, valuations are historically attractive, particularly for quality growth stocks.

We believe these factors should mean quality and growth are back on the menu. The key, however, is finding those stocks with the potential to deliver in their respective fields.

How does this look in practice?

Rational, a leading kitchen supplies company, has built a reputation for its high-quality products and commitment to customer satisfaction. With a range of innovative, efficient, and reliable kitchen appliances, Rational caters to professional kitchens worldwide. Its dedication to research and development has resulted in cutting-edge solutions that improve kitchen workflow and energy efficiency. Combine pricing flexibility with a leading presence in a specialised market, and it becomes clear why Rational could be a compelling long-term growth opportunity.

We believe companies that help promote and deliver more sustainable production and consumption will have a bright future. Take Borregaard. It utilises innovative technologies to transform wood and other biomass into advanced, eco-friendly chemicals. Its diverse products are used across agriculture, construction, and pharmaceuticals. Over 90% of its revenues come from its alternatives to oil-based products. Structural drivers for future growth – supportive regulation, ongoing demand for sustainable products and more – are also in place. We believe this combination of quality, growth and environmental responsibility makes Borregaard a leader in the bio-based chemicals sector.

Automation has revolutionised warehouses across the world. But given the complexities involved, safety is paramount. Enter Troax, a leading global manufacturer of safety and security solutions. The company specialises in high-quality mesh panel systems for machine guarding, warehouse partitioning, and property protection. These are used across various industries, such as automotive, manufacturing, and logistics.

As a growth story, Troax’s dedication to product development, combined with its ability to address specialist market requirements, potentially positions it well for continued expansion. One interesting area is active safety. This includes warehouse workers equipped with sensors that notify forklifts of their proximity, prompting the vehicles to decelerate and prevent collisions. Although still in its initial stages, this example demonstrates Troax's dedication to innovation.

Final thoughts…

Could the time for high-quality, small-cap growth stocks be here? We’re optimistic. Faced with a downturn, many investors will seek those firms that can deliver sustainable returns. They might also be tempted by historically low valuations. As ever, we advocate a fundamental, bottom-up approach to stock picking. It’s through the application of this process that companies like Troax, Borregaard and Rationale come to the fore. 

 

 

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