By Justin Thomson

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Value and small-caps could power international equities

There are significant structural opportunities at attractive prices.

November 2024, On the Horizon -

The extent to which the inflation and interest rate shocks of 2022 are reshaping the dynamics of international (ex U.S.) equities should become clearer in 2025. We expect there to be more evidence of a broadening opportunity set that favors international stock markets—and, within them, value and small‑cap stocks and countries such as Japan and South Korea.

We are emerging from a highly unusual period in which one market (the U.S.) and one sector (technology) dominated returns—and within that sector, a handful of exceptional firms drove the large bulk of those returns. This dominance has skewed investor positioning and valuations: Many investor portfolios are heavily exposed to U.S. equities while virtually every sector in non‑U.S. equities is currently cheaper than its U.S. equivalent.

Small‑caps appear positioned to deliver strong earnings growth

Valuations alone are not a compelling reason to invest in a particular market or asset class, but they do provide a useful starting point when determining the potential for long‑term returns. Within international markets, value stocks have been trading at a discount to growth stocks. This is likely to change as we expect non‑tech capex (capital expenditure) to surge amid widespread factory automation and the relocation of supply chains. The fastest‑growing firms in the period following the GFC were U.S. tech companies whose business models were built around intangible assets. We expect the period ahead to be marked by a higher‑trend level of demand for tangible assets, supporting sectors such as industrials, energy, and materials, which are typically value oriented.

International small‑caps (typically represented by the MSCI All Country World ex‑USA Small and Mid Cap Index) usually traded at a premium to large‑caps, but in 2024 this premium disappeared following several years of COVID‑related disruption and supply chain challenges (Figure 1). In our view, international small‑caps offer the potential to deliver stronger earnings per share (EPS) growth than their international large‑cap peers in the period ahead as the economic environment improves. History shows that following periods of earnings decline, earnings growth for small‑caps have typically exceeded large‑caps. We expect this to occur again on this occasion, but this time coming from a point of extreme valuation support for small‑caps that should help compound investor returns.

International small‑cap and large‑cap valuations have converged

(Fig. 3) The traditional premium of small‑caps has virtually disappeared

January 30, 2009 through October 31, 2024.
Source: MSCI (see Additional Disclosures). Analysis by T. Rowe Price.
P/E= Price-to-earnings. Past performance is not a reliable indicator of future results. Actual future results may differ materially from estimates.

The bull case for Japan still holds

The world will likely need to get used to a structural downshift in China from the 5% to 6% growth rates seen over the past few decades. A further challenge to Chinese growth may come if U.S. President‑elect Donald Trump delivers on his promise to impose more tariffs on China—although it is not yet clear how far any new measures will go, nor how much scope there is to negotiate a new trade deal between the two countries. In the meantime, the combination of compressed valuations, bottom‑up innovation, and potential for strong countertrend rallies means that opportunities to invest in China will continue to arise.

We believe the medium‑term bull case for Japan still holds as Japanese firms switch focus from market share to profit maximization. Although it is still in the early days, South Korea has sought to emulate Japan’s success in boosting stock valuations with a corporate governance drive. Tax incentives have been offered to businesses that prioritize shareholder returns, while the new “Korea ValueUp Index” will list firms that have improved capital efficiency.

These are significant structural opportunities available at attractive prices.

Key takeaway
We anticipate a broadening opportunity set that favors international markets, particularly value and small‑cap stocks.

Justin Thomson Head of International Equity

Justin Thomson is the head of International Equity. Justin is a member of the Management Committee and the chairman of the International Equity Steering Committee. He is a member of the Asset Allocation and ESG Committees. He also is the chief investment officer for International Equities. He is a vice president of T. Rowe Price Group, Inc., and T. Rowe Price International Ltd.

Nov 2024 • On the Horizon

U.S. exceptionalism has not run out of steam

By Blerina Uruçi

Nov 2024 • On the Horizon

Value and small-caps could power international equities

By Justin Thomson

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Value and small-caps could power international equities

Small‑caps appear positioned to deliver strong earnings growth

International small‑cap and large‑cap valuations have converged

The bull case for Japan still holds

U.S. exceptionalism has not run out of steam

Value and small-caps could power international equities

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