Is the Time Right for International Small Caps?

March 07, 2019

Most, if not all, of public equity markets have a cyclical nature to them, and international small cap equity is no exception. The growth of a dollar chart below shows 18 years of performance for the MSCI EAFE Small Cap Index.  As one can see, when performance is in a positive trend, it tends to remain in that trend for some time, and conversely, when performance is struggling, the struggle often persists for some time. Of course there are exceptions to these patterns – like the 2014 - 2016 period, but in general this trending pattern is quite robust.

Another quality of this performance is the tendency for declines to be more severe than advances… the cliché in the industry that “bull markets tend to climb the stairs, while bear markets tend to jump out the window!” supports this notion. This pattern likely stems from investors’ desire to avert losses – so when bad news comes out – the selling can be vicious – and sometimes overdone. In our view, it is precisely this quality – the tendency to overshoot the mark – or perhaps more specifically to overshoot fair value –   that historically has led to fairly strong recovery periods.

MSCI EAFE Small Cap Index
Drawdown period

Recent history suggests that strong recovery periods in international small cap equities tend to follow material drawdowns, more often than not. Of course past performance does not guarantee future results or repetition of past trends, but the chart above highlights this pattern. There have been six drawdowns of greater than 10% since December 31, 2000. In all but one, (1/31/2001 – 9/30/2001) the ensuing 12-month period generated at least a 20% return. In our white paper “4 Reasons to Invest in International Small Cap” we provide some compelling arguments for an allocation to this asset class. Given the recent historical pattern of corrections and recoveries, it may be an opportune time to consider investing.

 


4 Reasons to Invest in International Small Cap

 

 

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