Making a Case for International Small Cap Stocks
Editor’s Note: Jim Pearce has been writing about rotation all year — and today’s piece extends that thesis to international small cap stocks, where AI’s next deployment cycle is gaining steam. For the domestic side of that same playbook — traditional industrials, REITs, and operators quietly using AI to widen margins — see his AI Margin Rotation briefing →
A year ago, I explained why “The Case for Small Cap Stocks Just Got Stronger.” That article was published the week after President Trump signed his “Big, Beautiful Bill” (BBB) into law.
I said then, “The income tax cuts and other financial incentives included in the bill should spur more consumer spending during the second half of this year.” I further opined, “Companies of all sizes would benefit from more consumer spending, but smaller businesses should feel it more.”
To capitalize on that opportunity, I recommended buying shares of the State Street SPDR S&P 600 Small Cap Growth ETF (NYSE: SLYG). Since then, SLYG has gained 30 percent while the State Street SPDR S&P 500 ETF Trust is up 21 percent (through July 2).
That comparison is a bit misleading since all of the outperformance by SLYG has occurred within the past month as shown in the circled area of the chart above. And now that U.S. small cap stocks are taking off, I sense another opportunity in small cap stocks will soon follow that is literally a world apart from SLYG.
The AI Revolution is Moving Overseas
All the stocks held by SLYG are domiciled in the United States. I chose it a year ago because the economic benefits of the BBB would accrue almost entirely to domestic businesses.
I still believe SLYG will outperform the S&P 500 Index over the remainder of this year, but perhaps not to the same degree as the past year. Especially if the Fed feels compelled to raise interest rates in response to rising inflation.
Also, the artificial intelligence (AI) revolution that has powered our stock market to all-time highs is moving overseas. AI technologies developed primarily in the United States are now being rolled out to foreign markets.
For those reasons, I believe the timing is right to consider adding an international small cap growth fund to your equity portfolio if you don’t already own one.
State Street SPDR S&P International Small Cap ETF
We don’t have to look very far to find the type of fund that should work quite well for this purpose. The sponsor of SLYG also manages the State Street SPDR S&P International Small Cap ETF (NYSE: GWX).
This fund is designed “to provide investment results that, before fees and expenses, correspond generally to the total return performance of the S&P Developed Ex-U.S. Under USD2 Billion Index.” That’s a mouthful.
For inclusion in this fund, “a publicly listed company must have a total market capitalization between $100 million and $2 billion and be located in a country that meets the BMI Developed World Series criteria.” Further, “A country will be eligible for inclusion in the S&P Global BMI if it is classified as either a developed or emerging market by the S&P Global Equity Index Committee.”
Those countries include Japan, which accounts for 37 percent of the fund’s total assets. Next is South Korea at 11 percent, followed by Canada (10 percent), Australia (8 percent), and the United Kingdom (7 percent).
Fuel for Growth
The sector breakdown reflects the more diverse nature of those economies. Industrials represent 22 percent of the fund’s total assets, followed by Information Technology (15 percent), Materials (14 percent), and Consumer Discretionary (11 percent).
That allocation is quite different from the sector weightings of SPY, which is led by Information Technology at 37 percent followed by Financials (12 percent) and Communication Services (10 percent). In short, the technological innovations driving the U.S. economy will be used overseas to make those economies more productive and efficient.
As that happens, Wall Street will gradually reallocate money from large cap domestic stocks to small cap international companies. By the time the mainstream financial media start talking about it, much of the near-term upside potential will have already been realized.
The good news is it is not too late to make this trade. Thanks to dislocation in the global energy markets caused by the war in Iran, GWX has gained no ground since January.
I think that is about to change. The war in Iran appears to be over and fuel prices are coming down. The case for international small cap stocks is getting stronger.
The rotation I’m laying out today doesn’t end at GWX. The same forces driving capital into international small cap — AI deployment expanding beyond the U.S., leadership shifting from mega-cap tech toward industrials and materials — are playing out domestically too. I’ve built a portfolio around exactly that in Personal Finance: industrials cutting costs with AI, REITs housing the data buildout, traditional businesses quietly widening margins. Read the AI Margin Rotation briefing →
