The case for international small-cap stocks
July 2025, Monthly Market Playbook
- Key Insights
-
- Small-cap stocks appear cheap in both the U.S. and non-U.S. markets. But a number of favorable tailwinds are aligning behind international small caps.
- Debt burdens typically are less challenging for non-U.S. small-cap companies and interest rates are lower, especially in the eurozone and Japan.
- The international economic outlook has improved in both Europe and China. A weaker U.S. dollar also could enhance returns for U.S.-based investors.
- Small-cap stocks appear cheap in both the U.S. and non-U.S. markets. But a number of favorable tailwinds are aligning behind international small caps.
U.S. small-cap stocks are attractively valued but face challenges from high interest rates and a slow economy. One alternative is for investors to seek small-cap exposure outside the U.S., where numerous tailwinds appear to be aligning.
The U.S. stock market has become broadly expensive, with one major exception—small-cap stocks. Even after an uptick in valuations over the past three years, small caps are still priced below their longer-term averages.
Meanwhile, the difference between large-cap and small-cap valuations has become extreme. As of late July, the forward P/E for the S&P 600 Index—a widely followed U.S. small-cap benchmark—was more than seven multiples below the P/E for the S&P 500 Index.
This is not just a U.S. phenomenon. In fact, international small-cap stocks are even cheaper: As of late July, the MSCI All Country World ex U.S. Small Cap Index was priced at only 14.49 times forward earnings, slightly below the 15.02 P/E for the S&P 600.
One of the biggest challenges U.S. small caps face right now is the high level of interest rates.
After more than a decade of low or even near-zero rates, many small companies have become somewhat dependent on financing their operations using low-cost debt.
But stubborn inflationary pressures have forced the U.S. Federal Reserve to keep interest rates elevated for an extended period, creating a difficult operating environment for U.S. small caps.
Interest rates pose much less of a challenge for international small-cap stocks. This is because non-U.S. small-cap companies tend to hold significantly less debt than their U.S. counterparts.
And interest rates are quite a bit lower in most other countries—most notably in the eurozone and Japan.
Another headwind for U.S. small caps has been a relatively sluggish U.S. economy. After achieving a “soft landing” in 2023, the U.S. economy has remained soft outside of a few specific areas, such as the boom in artificial intelligence spending.
Growth expectations outside the U.S. also have been somewhat soft . . . until recently. But the German government’s March decision to lift its so-called “debt brake”—which is a borrowing restriction in place since 2009—has created a sharp pivot in economic expectations for Europe. More than a decade of fiscal austerity in the eurozone appears to be coming to an end.
Meanwhile, growth expectations in China also have improved considerably due to an uptick in both monetary and fiscal stimulus.
The bottom line is that numerous tailwinds appear to be aligning behind international small-cap stocks. In addition to lower interest rates and increased fiscal stimulus, non-U.S. small caps are benefiting from an improving mergers and acquisitions environment. Promising start-ups outside the U.S. are also less likely to be snapped up by venture capital firms, expanding the small-cap opportunity set for public investors.
As a result, international small caps have outpaced the U.S. large-cap market so far in 2025. Through July 22, the MSCI All Country World ex U.S. Small Cap Index returned 12.22% versus only 7.99% for the S&P 500.
This performance advantage has been even larger for U.S.-based investors, thanks to U.S. dollar weakness against most major currencies. A weaker dollar has tended to enhance the value of assets—and earnings—that are priced in foreign currencies. In U.S. dollar terms, international small caps returned more than 20% for the year through July 22nd.
We think that continued dollar devaluation is a distinct possibility. After nearly 15 years of strong appreciation, the U.S. currency is still expensive, despite recent weakness. Elevated geopolitical and trade tensions, and ongoing questions about the independence of the U.S. Federal Reserve, also could weigh on the demand for dollars.
Smaller non-U.S. companies offer both attractive valuations and an outlook that appears to be strengthening on many fronts. As a result, the T. Rowe Price Asset Allocation Committee recently initiated a significant overweight position in international small-cap stocks.
Small-cap U.S. stocks are attractively valued but face challenges from high interest rates and a sluggish economy. One alternative is for investors to seek small-cap exposure outside the U.S., where numerous tailwinds appear to be aligning.
The U.S. stock market has become broadly expensive, with one major exception—small-cap stocks. Even after a valuation uptick over the past three years, small caps still are priced below their longer-term averages and more than seven multiples below the S&P 500 Index (Figure 1).
But international small caps appear even cheaper: As of late July, the MSCI All Country (AC) World ex U.S. Small Cap Index was priced at only 14.49 times forward earnings, slightly below the 15.02 price-to-earnings (P/E) ratio for the S&P 600 Index—a widely followed U.S. small-cap benchmark.
One of the biggest challenges U.S. small caps face right now is high interest rates. After more than a decade of low or even near-zero rates, many small-cap companies have become somewhat dependent on financing their operations with low-cost debt. But stubborn inflationary pressures have forced the U.S. Federal Reserve to keep interest rates elevated for an extended period—creating a difficult operating environment for U.S. small caps.
Interest rates pose much less of a challenge for international small-cap stocks. Non-U.S. small-cap companies tend to hold significantly less debt than their U.S. counterparts. Interest rates also are lower in many other countries—most notably in the eurozone and Japan.
The economic environment looks better outside the U.S.
Another headwind for U.S. small caps has been a relatively sluggish U.S. economy. Growth expectations outside the U.S. also have been somewhat soft—until recently. But the German government’s March decision to lift its so-called “debt brake”—a borrowing restriction in place since 2009—has created a sharp pivot in economic expectations for Europe (Figure 2). Meanwhile, growth expectations in China also have improved considerably.
Small-cap stocks are cheap everywhere
January 2015 through July 21, 2025.
Actual future outcomes may differ materially from estimates.
Sources: Standard & Poor’s, MSCI via FactSet.
1 P/E ratios based on 12-month forward earnings per share consensus estimates.
The bottom line is that numerous tailwinds—including lower interest rates, increased fiscal stimulus, and an improving mergers and acquisitions environment—appear to be aligning behind international small caps. Promising start-ups outside the U.S. also are less likely to be snapped up by venture capital firms, expanding the small-cap opportunity set for public investors.
As a result, international small caps have outpaced the U.S. large-cap market so far in 2025. Through July 22, the MSCI AC World ex U.S. Small Cap Index returned 12.22%, versus only 7.99% for the S&P 500.
This performance advantage has been even larger for U.S.-based investors, thanks to U.S. dollar weakness against most major currencies. A weaker dollar has tended to enhance the value of assets—and earnings—that are priced in foreign currencies. In U.S. dollar terms, international small caps returned more than 20% for the year through July 22.
We think continued dollar devaluation is a distinct possibility. After nearly 15 years of strong appreciation, the U.S. currency is still expensive, despite recent weakness. Elevated geopolitical and trade tensions, and ongoing questions about the independence of the U.S. Federal Reserve, also could weigh on the demand for dollars.
Conclusion
Smaller non-U.S. companies offer both attractive valuations and an outlook that appears to be strengthening on many fronts. As a result, the T. Rowe Price Asset Allocation Committee recently initiated a significant overweight position in international small-cap stocks.
The international growth outlook is improving
January 2000 through April 2024.
Actual future outcomes may differ materially from estimates.
Source: Bloomberg Survey of Economists, Bloomberg Finance L.P.
1 German debt ratio by Maastricht definition. Real GDP = after inflation.
Timothy C. Murray, CFA
Capital Markets Strategist
Jul 2025
Monthly Market Playbook
Article
Taking a measured approach with high yield bonds
Risks
Small-cap stocks have generally been more volatile in price than the large-cap stocks.
Additional Disclosures
CFA® and Chartered Financial Analyst® are registered trademarks owned by CFA Institute.
Important Information
Outside of the United States, this is intended for investment professional use only. Not for further distribution.
This material is being furnished for informational and/or marketing purposes only and does not constitute an offer, recommendation, advice, or solicitation to sell or buy any security.
Prospective investors should seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services.
Past performance is not a guarantee or a reliable indicator of future results. All investments involve risk, including possible loss of principal.
Information presented has been obtained from sources believed to be reliable, however, we cannot guarantee the accuracy or completeness. The views contained herein are those of the author(s), are as of August 2025, are subject to change, and may differ from the views of other T. Rowe Price Group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.
All charts and tables are shown for illustrative purposes only. Actual future outcomes may differ materially from any estimates or forward‑looking statements provided. Index performance is for illustrative purposes only and is not indicative of any specific investment. Investors cannot invest directly in an index.
The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request.
Australia—Issued by T. Rowe Price Australia Limited (ABN: 13 620 668 895 and AFSL: 503741), Level 28, Governor Phillip Tower, 1 Farrer Place, Sydney NSW 2000, Australia. For Wholesale Clients only.
Canada—Issued in Canada by T. Rowe Price (Canada), Inc. T. Rowe Price (Canada), Inc.’s investment management services are only available to non‑individual Accredited Investors and non‑individual Permitted Clients as defined under National Instrument 45‑106 and National Instrument 31‑103, respectively. T. Rowe Price (Canada), Inc. enters into written delegation agreements with affiliates to provide investment management services.
EEA—Unless indicated otherwise this material is issued and approved by T. Rowe Price (Luxembourg) Management S.à r.l. 35 Boulevard du Prince Henri L‑1724 Luxembourg which is authorised and regulated by the Luxembourg Commission de Surveillance du Secteur Financier. For Professional Clients only.
New Zealand—Issued by T. Rowe Price Australia Limited (ABN: 13 620 668 895 and AFSL: 503741), Level 28, Governor Phillip Tower, 1 Farrer Place, Sydney NSW 2000, Australia. No Interests are offered to the public. Accordingly, the Interests may not, directly or indirectly, be offered, sold or delivered in New Zealand, nor may any offering document or advertisement in relation to any offer of the Interests be distributed in New Zealand, other than in circumstances where there is no contravention of the Financial Markets Conduct Act 2013.
Switzerland—Issued in Switzerland by T. Rowe Price (Switzerland) GmbH, Talstrasse 65, 6th Floor, 8001 Zurich, Switzerland. For Qualified Investors only.
UK—This material is issued and approved by T. Rowe Price International Ltd, Warwick Court, 5 Paternoster Square, London EC4M 7DX which is authorised and regulated by the UK Financial Conduct Authority. For Professional Clients only.
USA—Issued in the USA by T. Rowe Price Investment Services, Inc., distributor and T. Rowe Price Associates, Inc., investment adviser, 1307 Point Street, Baltimore, MD 21231, which are regulated by the Financial Industry Regulatory Authority and the U.S. Securities and Exchange Commission, respectively.
© 2025 T. Rowe Price. All Rights Reserved. T. Rowe Price, INVEST WITH CONFIDENCE, the Bighorn Sheep design, and related indicators (see troweprice.com/ip) are trademarks of T. Rowe Price Group, Inc. All other trademarks are the property of their respective owners.
- 202507-4695944