International Small Caps: Compelling Valuations May Mark an Attractive Entry Point

It can be argued that signals are the catalysts behind the vast majority of actions we take in life. Seeing a red light signals us to stop the car; feeling rain drops on our head signals us to open our umbrella; hearing a familiar song may even signal us to smile and sing along. The same concept can be applied to financial markets, as there is an assortment of signals that may help investors make investments with a certain level of confidence. While past performance signals and future forecasting methods do not guarantee success, they can be useful context in seeking to understand different market environments and potentially make more informed decisions. Regarding international small caps, there are countless signals that can be used to analyze the asset class. However, we would like to focus on one particular signal that we believe to be associated with strong long-term returns: valuation.

• The EAFE Small Cap Index is currently trading at a forward price-to-earnings (P/E) ratio of 13.0x, which is a -10% discount relative to the long-term (since 2001) average of 14.4x.
• These valuation levels have not been seen in more than a decade, notably since 2012.

While being careful not to disregard other signals and macroeconomic factors, current valuation levels for the MSCI EAFE Small Cap Index have led to attractive annualized total returns over the subsequent 3 years.

It is our view that current international small cap valuations present a compelling opportunity for investors seeking to diversify their portfolios and capitalize on potential growth. These valuation discounts don’t just create a favorable entry point for investors, but may also be indicators of how the asset class may perform in the months and years that follow. Moreover, we believe the global economy has gradually rebounded from recent challenges, and international small caps are well-positioned to benefit from this resurgence in addition to domestically-oriented dynamics. Click here to read more about why we believe investors’ portfolios may be underweight in this distinct asset class: Time to Up Your Serving Size of International Small Caps.

Important Information

The views expressed herein may not be reflective of current opinions, are subject to change without prior notice, and should not be considered investment advice.

Past performance is no guarantee of future results.

All investments involve risk including the possible loss of principal. Stock prices can fall because of weakness in the broad market, a particular industry, or specific holdings. At times, a growth investing style may be out of favor with investors which could cause growth securities to underperform value or other equity securities. Foreign securities may be subject to greater risks than investing only in the U.S. These risks are more severe for securities of issuers in emerging market region and may be more volatile and less liquid due to currency fluctuation, political instability, government sanctions, social and economic risks. Foreign currencies can decline in value and can adversely affect the dollar value of an investment. Investing entails risks and there can be no assurance that any investment will achieve profits or avoid incurring losses.

The MSCI EAFE Small Cap Index is an equity index which captures small cap representation across developed markets countries around the world, excluding the US and Canada. This unmanaged index does not reflect fees and expenses and is not available for direct investment.

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Forward P/E Ratio: a measure of the P/E (price-to-earnings) ratio using forecasted earnings for the P/E calculation.

This material may reference countries which may be generally the subject of selective sanctions programs administered. Readers of this commentary are solely responsible for ensuring that their investment activities in relation to any sanctioned country are carried out in compliance with applicable laws, rules or policies.

Harbor Capital Advisors, Inc.

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