UK small-cap shares are having a mixed year, trailing their eurozone counterparts and struggling to gain sustained momentum.
According to a note from JP Morgan, this underperformance reflects weaker economic indicators at home, particularly business activity surveys, which have a strong historical correlation with the relative performance of UK small caps.
The sector's relative performance is strongly correlated to the activity momentum, the bank noted.
And at the moment, that momentum is firmer on the continent than in the UK.
Purchasing managers’ indices, which track private sector activity, have been more positive across the eurozone, where smaller companies are outperforming their large-cap peers.
The difference in policy backdrop is also playing a role. “Eurozone fiscal tailwind is likely much stronger than the UK one,” JPM wrote, pointing to the broader support measures available in European economies compared with the more constrained UK outlook.
While UK small-cap investors may be waiting for better days, the picture is more encouraging elsewhere.
The American bank argues that selected international small-cap markets now offer a better balance of risk and reward, supported by attractive valuations, light investor positioning, and the sheer length of their recent underperformance.
“Valuations of small caps are attractive in most places,” the analysts say, and after years of lagging, the bar for improvement is low.
Macro supports building
Beyond valuation, several macroeconomic factors could tilt the scales in favour of smaller companies. For one, international small caps tend to be more insulated from global trade tensions than large multinationals.
Their more domestic focus also makes them a relative beneficiary of a weakening US dollar, which JP Morgan expects to continue into the year-end.
Interest rates could provide another boost. Smaller businesses are generally more sensitive to borrowing costs, so if bond yields and policy rates begin to fall, as many expect, “small caps are likely to be supported,” the bank says.
Regional trends diverge
The US remains a drag. American small caps have once again underperformed this year, though there are signs of a tentative turnaround.
“Most recently, they are starting to trade better,” the analysts note, citing possible drivers such as the prospect of more aggressive interest rate cuts by the Federal Reserve and recent tax reforms, some of which could improve cash flows for smaller firms.
Japan also features in JPM's favoured list. The bank upgraded its view on non-US small caps last summer, turning positive on Europe and Japan after years of backing large caps.
That call remains in place, with the analysts noting that international small caps appear to be bottoming out.
Within Europe, Germany stands out. The bank is overweight the MDAX, a benchmark for mid-sized German companies, and highlights their performance this year as encouraging.
Overall, the small-cap revival is still selective. But with valuations low and policy winds potentially shifting, the conditions for a broader recovery are starting to take shape... just not yet in the UK.