by: Lawrence Hamtil
When comparing global equity markets, the tendency is to use the large capitalization equity indices as proxies. This makes sense as the large capitalization stocks that compose these indices are typically the most well-known and consequential stocks in a given market. These large companies also tend to be multinationals, and are thus usually the most exposed to the global economy, while the fortunes of small-cap stocks tend to be more aligned with the goings-on of the local economy in question.
Sometimes, there can be a divergence between the large-cap and small-cap stocks in a given market. Investors can look at Europe as an example. The economy in Europe has been dealt several blows by the debt crisis in Greece as well as the war in Ukraine. It is widely noted that large capitalization European companies have lagged their American counterparts for a few years now, despite years of dramatic outperformance early in this century [Note: the lower the ratio, the better the relative performance of the comparable foreign index to its American counterpart]:
The relative underperformance of large European companies is now well above the level seen in the wake of the global tech bust in 2000-2002. A common explanation for this - and one that I endorse - is the recent surge in the US dollar versus the euro. The impact of dollar strength on US equity outperformance is obvious. As the dollar has weakened versus the euro, the US has done better. When the dollar has strengthened versus the euro, the reverse has occurred:
Investors could be forgiven for thinking that, because the dollar has surged versus the euro (as well as the British pound and Swiss franc, for that matter), probably all European stocks have underperformed American stocks of late. However, a glance at European small capitalization stocks tells a much different story:
Amazingly, it has been only since the last months of 2016 that American small capitalization stocks have regained their relative advantage versus European small capitalization stocks, an advantage they last had in 2004.
It is fascinating that the dollar surge has not had nearly the same impact on European small capitalization stocks that it has had on large capitalization European stocks:
Comparing the relative performance of European small-cap stocks with other foreign small caps reveals much the same: European small caps have held up rather well, despite the surge in the dollar versus other currencies [Note: This data series begins in January 2002, the earliest for which MSCI World ex-USA Small Cap data are available.]:
I am at somewhat of a loss as to how this phenomenon can be explained. A quick glance at the differences in sector composition may reveal part of the answer as the European large capitalization index maintains much larger weightings in more dollar-sensitive industries such as materials, while having little exposure to the global technology sector:
The US small capitalization space is heavy in financials, which are only now regaining the life they seemed to have lost for good during the financial crisis, while Europe's small capitalization market is composed largely of industrials and consumer stocks, which seem to have withstood the post-crisis European malaise much better than their large European counterparts, which, like US small-caps, are heavy in financials and other lagging industries.
Investors who are considering Europe as an investment destination, but who are also concerned about continued euro weakness, may want to consider looking at European small capitalization stocks that, while perhaps appearing not as cheap as large capitalization European stocks, would give added diversification without as much sensitivity to exchange rate volatility.
Disclosure: The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index.
This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Fortune Financial Advisors, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Fortune Financial Advisors, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.
The information provided above is obtained from publicly available sources and it is believed to be reliable. However, no representation or warranty is made as to its accuracy or completeness.
Lawrence Hamtil is a fourteen-year veteran of the financial services industry, having served clients in all aspects of the business during his career, which started in 2002. In 2005, he joined Dennis Wallace of Fortune Financial Services, LLC, becoming, at the time, one of Multi-Financial Securities, Inc's youngest registered representatives. In 2008, Dennis and Lawrence made the decision to become fully independent by founding their own Registered Investment Advisory (RIA), Fortune Financial Advisors, LLC. He serves clients in the United States and Europe. His financial commentary has been referenced in Barron’s online edition.
You can connect with Lawrence on Twitter ( @lhamtil) or via email, email@example.com.
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