Small-Cap Growth: A Contrarian's Play in Tariff-Turbulent Markets

The first quarter of 2025 was a litmus test for small-cap growth investors. As tariff-driven market turbulence roiled equities—sending the Russell 2000® Growth Index down 11.12%—the Thrivent Small Cap Growth Fund underperformed its benchmark by 118 basis points. Yet beneath the headline losses lies a compelling narrative: small-cap growth stocks, particularly those with secular tailwinds and policy resilience, are emerging as contrarian opportunities. Thrivent's strategic shifts toward domestically focused sectors and AI-driven innovation suggest that now—amid valuation discounts and shifting policy landscapes—could be the time to selectively allocate to this segment of the market.

The Case for Contrarian Optimism

The fund's Q1 stumble was sector-specific. Information Technology holdings, including a semiconductor firm, faced headwinds as tariffs disrupted supply chains and datacenter spending waned. Meanwhile, a Health Care holding struggled with operational missteps tied to an ERP system overhaul. These setbacks, while painful, highlight the fund's disciplined approach to risk management: sectors with exposure to cyclical demand or geopolitical flashpoints were de-emphasized.

But the broader picture is more promising.

. Consider Thrivent's outperformance in consumer discretionary, where a factory-built housing company thrived by addressing the U.S. housing affordability gap. This firm's gross margins stabilized as consumers turned to cost-effective housing solutions, a secular trend amplified by rising mortgage rates. Similarly, an insurance brokerage in the financials sector rebounded with double-digit organic revenue growth, underscoring the resilience of companies with strong balance sheets and niche market dominance.

These holdings illustrate a core thesis: small-cap growth is not a monolith. While tariff-sensitive sectors reeled, domestic-facing businesses with pricing power or structural growth drivers held up better. Thrivent's pivot to such names sets the stage for a rebound—if investors look past near-term volatility.

Valuation Discounts and Policy Tailwinds

The fund's Q1 struggles have created a valuation sweet spot. The Russell 2000® Growth Index now trades at a forward P/E ratio of 18.4x—below its five-year average of 21.2x—a discount that reflects both macro fears and sector-specific pessimism. For contrarians, this compression presents an entry point, especially given two critical tailwinds:

1. Policy Shifts: The new administration's focus on reducing regulatory burdens and lowering corporate taxes could disproportionately benefit small-cap firms. Unlike large multinationals, smaller companies are often U.S.-centric, making them direct beneficiaries of domestic policy easing.
2. AI and Innovation: Thrivent's emphasis on AI-driven sectors—think automation software or data infrastructure—aligns with a long-term theme. While near-term spending cuts have spooked investors, the fund's focus on companies with scalable AI adoption (e.g., process optimization in manufacturing) positions it to capture post-tariff productivity gains.

Navigating Near-Term Risks

The path to growth is not without hurdles. Tariff disputes and Federal Reserve caution remain risks. The Fed's reluctance to cut rates aggressively—despite core inflation easing to 2.8%—could prolong small-cap liquidity strains. Meanwhile, corporate bond spreads, though stable for now, could widen if earnings downgrades accelerate.

Yet history favors contrarians in such environments. Since 2000, the Russell 2000 Growth has outperformed the S&P 500 by an average of 12% in the 12 months following quarterly declines exceeding 10%. Thrivent's focus on risk-adjusted resilience—prioritizing companies with strong cash flows, manageable debt, and secular demand drivers—aligns with this cyclical pattern.

A Selective Call to Action

Investors should not blanket-allocate to small caps. Instead, target funds like Thrivent's that demonstrate:
- Sector agility: Shifting away from tariff-exposed industries to domestically oriented sectors (e.g., housing, insurance, and tech with U.S. revenue concentration).
- Valuation discipline: Avoiding overleveraged firms while favoring those trading at discounts to their growth profiles.
- Policy foresight: Engaging in scenario analysis to navigate regulatory changes, as Thrivent's managers did with their ERP-related underperformers.

Conclusion

The Thrivent Small Cap Growth Fund's Q1 stumble is a symptom of a broader market correction—one that has created a rare opportunity. With valuations attractive, domestic policy tailwinds gathering strength, and select companies proving their resilience, now is the time to consider a strategic tilt toward small-cap growth. The turbulence of tariffs may yet yield a harvest of long-term gains for investors willing to look beyond the noise.

Investment advice: Consider a gradual allocation to small-cap growth via funds like Thrivent's, focusing on sectors with domestic revenue exposure and AI-driven innovation. Monitor tariff negotiations and Fed rate decisions for tactical adjustments.