Last week saw the UK and US shake hands on a deal over tariffs that managers are cautiously predicting will light a fire under out-of-favour smaller domestic stocks.

After chancellor Rachel Reeves’ visit to Washington, the Trump administration made some concessions for UK imports into the world’s largest economy. 

The blanket 10% on imports entering the US still applies to most UK goods, but trade levies on some of the UK’s exports - notably cars, steel and aluminium – have been either reduced or removed. 

Stifel analyst Iain Scouller believes smaller businesses will profit most from the deal due to their more focused nature. 

‘Large FTSE 100 companies tend to have sprawling businesses with lots of moving parts and many factors influencing their share prices,’ he said.

By contrast ‘many UK mid- and small caps have more focused businesses and stand to benefit from the clarity provided by a deal’.

The FTSE Small Cap index, excluding investment companies, has been on the slide since the UK Budget at the end of October, which brought added pressure for companies with an increase in employer national insurance payments and a higher minimum wage. According to Stifel data, the index fell 8.7% to 25 April, while the FTSE 250 fell 5.5%.

The weakness in the sector has also been reflected in widening discounts, with many mid and small-cap trusts broaching mid-teen levels in early April on tariff worries, and the average trust in the Deutsche Numis UK smaller companies sector sitting at a discount of 11.3%, while mid-cap trusts average 8.4%. The hope is that a trade deal with the UK’s largest goods export market will be the catalyst needed to shift investor sentiment back in the sector’s favour. 

A ‘cautious welcome’ from Roche

Talking to Citywire, Jean Roche, manager of Schroder UK Mid Cap (SCP ) , which has the capacity to lean into international revenue pools and companies, said the deal deserves ‘a cautious welcome’. 

‘The headline of a trade deal is good news for this kind of trust and it’s helpful for sentiment towards UK companies that are domestically-listed more generally,’ she said. 

‘It looked like the UK was in there quickly and that special relationship is solid. In a world where uncertainty makes investors hold back, it’s a good thing that the UK has a bit more certainty than other markets.’

On a more cautious note, Roche flagged on the fast pace of advancements around tariffs, stating ‘discussions around other trade agreements will also affect UK market returns’.

‘If you had a very UK-focused portfolio last Friday, that would be exactly the right place to be and then you have some good news on China and potentially a US-China trade agreement, and you need to own very different stocks,’ she said. 

‘Your perfect portfolio on Monday is not going to be your perfect portfolio on Tuesday, that’s just the way it’s going to be with volatility this year’. 

She also pointed to accusations from Beijing that the UK has slighted China with the deal, implicitly agreeing to a slowdown in trade between the two countries. Roche said: ‘It’s worth asking the question, at what point do other countries get fed up?’

Ultimately though, Roche felt that cheaply-valued, domestic small and mid-caps would prove most attractive to risk-averse investors buying off the back of the deal. 

‘People were already warming up to the UK because of cheap valuations, particularly in UK small and mid-caps,’ she said.

‘There are some incredibly interesting growth stories within the FTSE 250 – it’s not just a bunch of housebuilders and domestic retailers, though those are the more interesting places to be at the moment.’

Stay away from the ‘FTSE 40’

James Thorne, fund manager of the UK small-cap portion of the Global Smaller Companies (GSCT ) reiterated Roche’s optimism for the deal with the US.

‘The deal has very good optics for the US and also for the UK,’ said Columbia Threadneedle’s Thorne, adding that ‘it’s been incredibly important for the UK automotive industry in particular, having certainty around pricing’.

Thorne also voiced concerns that ‘disruption of demand’ from the first roll-out of tariffs ‘will continue to have implications for the second half in terms of corporate profitability’.

He felt investors would still be cautious around larger UK companies, and said ‘you don’t want to invest in the “FTSE 40”, the dominant part of the FTSE 100, because they’re primarily international businesses that rely on global growth and when you get below that level you’re much more into the domestic market’.

He concluded that ‘the critical thing’ for the UK market is ‘its own domestic recovery’, stating ‘there is a lot of domestic demand that hasn’t been there, and just a normalisation of that domestic demand will support the UK economy’.

His £789m portfolio has felt the strain of the downbeat sentiment towards small-caps over the past year, with a NAV decline of 3.2% versus a slight 0.4% rise in the MSCI World Small Cap index.