Feeling Supersonic: SMCO 2024 Review and 2025 Outlook

2024 provided investors with no shortage of ups and downs, beginning with a strong rally but ending with a whimper. Despite the subdued finish, it was a profitable year overall, with most equity market indices delivering healthy gains. The small- and mid-cap (smid) space posted solid returns, though large-cap stocks once again led the way. This was largely driven by the excitement and significant investment surrounding AI, which primarily benefited mega-cap companies. Interestingly, much of this spending also came from large-cap firms. Aside from a mid-year bout of skepticism around “where’s the ROI?!?”, these companies were largely given the benefit of the doubt, as markets appeared confident that ROI would eventually materialize. Most other stocks lagged behind the "Magnificent Seven," leaving the potential for broader, more evenly distributed returns still unrealized. For those of us focused on small- and mid-cap stocks, a more balanced market would be welcome, but achieving solid absolute returns in the meantime is far from disappointing.

As we look to 2025, the year begins with both promise and challenges. We feel that the backdrop of solid economic growth, moderated inflation, and a resilient employment landscape (though all these variables merit a watchful eye) creates a constructive environment for equities. Additionally, the potential for business-friendly policy changes could provide further support for markets. While we would welcome greater market breadth, we see opportunities regardless.

4Q Review

Equity markets rose throughout the fourth quarter but experienced a notable slowdown as the year drew to a close. After edging higher in the lead-up to the election, markets surged following the Republican sweep, particularly through late November. We had anticipated that a split outcome between the presidency and Congress—removing the possibility of policy extremes—would be the most market-friendly scenario, so the strong rally caught us by surprise. The results buoyed sentiment on both Main Street and Wall Street, likely fueled by memories of the economic and market surge at the start of President Trump’s first term, optimism about a thin majority keeping policy moderate, or a combination of both.

However, by late November, reality began to set in, and stocks lost momentum heading into year-end. The initial post-election enthusiasm gave way to concerns about a less accommodative Federal Reserve outlook, emerging signs of weakness in employment, and other uncertainties. In this environment, the "Magnificent Seven" once again took center stage, supported by strong demand prospects and robust balance sheets. While we welcomed some moderation after the election rally—viewing the exuberance as somewhat overdone—the dominance of a narrow group of stocks underscored ongoing challenges in achieving broader market participation.

All told, SMCO delivered a solid quarter, posting returns of 2.66% net/2.80% gross, outperforming the Russell 2500’s modest 0.62% gain. We kept pace during the post-election rally and pulled ahead during the subsequent market pullback. Strong performance from our Technology, Financials, and Communication Services holdings drove results, while Real Estate, Healthcare, and Materials weighed on returns. At the stock level, Kyndryl, Ciena, and Primoris were standout contributors, while Americold Realty, Booz Allen Hamilton, and Teleflex were the largest detractors.

However, analyzing unweighted performance (pure appreciation/depreciation) revealed some differences. Kyndryl, Ciena, and Primoris remained top performers, but Amentum, ICF International, and Teleflex saw the steepest percentage declines. Teleflex struggled with ongoing top-line challenges, while Amentum and ICF International were impacted by the so-called “DOGE” effect—market concerns over newfound government efficiency initiatives weighing on service contractors. Anticipating these concerns, we acted preemptively by liquidating our position in Maximus and significantly reducing our position in ICF International. While these moves mitigated some impact, we still experienced some downside. While some adjustment in these stocks was appropriate, we believe the market’s reaction was overdone. Historically, government efficiency efforts often translate into more business for contractors, not less. While changes to contract structures and spending priorities are likely—particularly in civilian areas—we remain optimistic about the prospects for our remaining government services holdings.

Turnover remained light this quarter at under 5%, consistent with our disciplined approach. Most trades reflected our hallmark position size management, though we also eliminated Maximus and initiated a new position in Jack Henry. Jack Henry, a leading provider of technology solutions for small banks and credit unions, caught our attention after an unusually weak 2024. Despite this short-term setback, we believe Jack Henry is well-positioned for an acceleration in both top-line and profit growth, supported by its innovative offerings and robust client relationships.

Full Year 2024 Review

SMCO delivered a strong full-year return of 18.18% gross and 17.57% net, significantly outperforming the Russell 2500’s 12.00% gain. Our performance was driven primarily by holdings in Industrials, Technology, and Financials, reflecting the strongest areas of the small- and mid-cap market. Thematically, our focus on physical and digital infrastructure paid off, with standout contributions from Primoris, EMCOR, and Ciena. Additionally, Sprouts Farmers Market performed well within the New Consumer theme, while Kyndryl—a pure alpha idea—rounded out our top five contributors.

On the downside, Healthcare and Real Estate were the only sectors with negative returns for the year. Real Estate performance was weighed down by Americold Realty and Digital Bridge, while Coty, Wolfspeed, and Ulta Beauty were notable detractors elsewhere. Weak industry data in the beauty segment prompted us to review our New Consumer holdings in this area. As a result, we exited both Coty and Ulta but retained e.l.f. Beauty, though at a reduced weight. We continue to view e.l.f. Beauty as a secular winner worth holding despite broader industry challenges.

Turnover for the year was modest at under 17%, consistent with our long-term investment approach. While we remain ready to adjust the portfolio more actively if needed, our focus on identifying long-term secular winners allows us to generate strong returns with lower turnover. This disciplined strategy served us well throughout 2024.

2025: The year of the comeback? Definitely Maybe

In the mid-1990s, a band from Manchester, UK—Oasis—rose from obscurity to become the biggest band in the world. Led by the ever-entertaining Gallagher brothers, Noel and Liam, they delivered straightforward rock music, a refreshing departure from the grunge-dominated sound of the time. Like many others, I was instantly a fan. However, as is often the case with bands that experience meteoric success, they burned out as quickly as they rose. Infighting and the usual rock-and-roll chaos led to acrimony, waning popularity, and their eventual breakup, with the brothers famously at odds. Since then, their public feuds made a reunion seem impossible—until now. To the surprise and delight of their fans, Oasis is reuniting for a triumphant 2025 tour. I was thrilled to discover that one of my daughters has also become a true fan—a proud dad moment! She and I will be traveling to Dublin this summer to see them live. You might wonder why we’re going all the way to Ireland when they’re also playing North American dates. Well given the band’s—ahem—history, we decided seeing them early in the tour might be a good idea. We hope they can stay copacetic and carry on through the North American leg, but we have our doubts!

By now some of you must be wondering “where the heck is this going?” Well, we believe proposed upcoming policy changes and their possible implications will be major considerations for 2025, and we see parallels between Trump II and the Oasis reunion tour. Here’s a table to clarify:

Key: 🍊 = Trump Term II 🎸= Oasis Reunion Tour

We concede the parallels may be a bit of a stretch—and we’re having some fun here—but in all seriousness, Trump’s reelection seemed as improbable as the Oasis reunion tour. Yet here we are. His second term could create conditions conducive to strong small- and mid-cap performance, and we stand ready to capitalize on those opportunities should they develop. Alternatively, if conditions sour, we are prepared to adjust accordingly. What does seem likely in almost any scenario—and has already begun to emerge—is the return of volatility. Separating signal from noise, always a challenge for investors, will only become more difficult. In our view, this underscores the importance of an active approach to the small- and mid-cap market.

As we enter the year, we lean optimistic but recognize that the market faces significant challenges. Valuations are not egregious but are also not particularly cheap. Further market appreciation will depend more on earnings growth acceleration than on multiple expansion. We think that this is especially true in the small- and mid-cap space, where earnings growth is expected to accelerate meaningfully (see below). While 20%-plus earnings growth is possible, it is by no means guaranteed. We believe our focus on companies that deliver superior results will serve the portfolio well.

The Masterplan

Generating a positive absolute return is always our primary objective, but the outperformance in 2024 was especially rewarding after lagging a very strong 2023 small- and mid-cap market. Our focus remains on performance over a full market cycle, which requires executing a consistent, repeatable process—even if that occasionally leads to periods of underperformance. That said, the strong results in 2024 leave SMCO with above-market returns (as defined by the Russell 2500) on a one-year, three-year, five-year, and inception-to-date basis. While this is gratifying, we—like the markets—always look forward, not backward. The market presents new challenges every day, there is no time to become complacent. Rest assured, we are continuously evaluating our current holdings, monitoring market conditions, and searching for the next great investment opportunity.

Thank you for your continued support. We wish you a prosperous and productive 2025. Here’s hoping 2025 turns out to be a Champagne Supernova—and that none of us have to look back in anger.

(Editor’s note: extra points for those who pick up on the references. If you know, you know…)