Navigating Trump's Tariff Volatility: Strategic Opportunities in European Small-Cap Equities

In an era defined by geopolitical uncertainty and shifting capital flows, investors are increasingly seeking alternatives to the dominance of U.S. large-cap equities. The resurgence of protectionist policies under the Trump administration, marked by aggressive tariff hikes and a reorientation of global trade dynamics, has created volatility that traditional safe havens struggle to mitigate. Yet, within this turbulence lies a compelling opportunity: European small-cap equities, undervalued and resilient, offer a strategic hedge against trade uncertainty while benefiting from capital reallocating away from overvalued U.S. assets.

The Case for European Small-Cap Equities

The interplay of monetary easing, fiscal reforms, and sectoral realignment has positioned European small-cap stocks as a unique asset class. Central banks across Europe have embraced a more aggressive rate-cutting cycle—by April 2025, the European Central Bank (ECB) had reduced rates to 2.25%, with the Bank of England following suit in May. These cuts, coupled with lower borrowing costs, have improved the cost of capital for small-cap firms, which often operate in cyclical sectors like industrials and materials. These sectors, in turn, are poised to benefit from onshoring trends driven by the desire to shorten supply chains amid U.S. tariff threats.

The valuation gap between European small-caps and their U.S. counterparts is striking. As of May 2025, European small-cap equities trade at a forward price-to-earnings (P/E) ratio approximately 40% below that of the S&P 500. This discount reflects not just macroeconomic caution but also the underappreciated resilience of small-cap firms with strong local market positions. For instance, Coats Group (COATS.L), a global leader in industrial thread manufacturing, trades at a P/E of just 12x despite reporting 27.56% annual earnings growth. Its recent £242 million equity offering, while dilutive, has been offset by insider confidence and robust cash flows from its $705 million in first-half 2025 sales.

Similarly, Borregaard (BOR.N), a Norwegian biochemicals company specializing in wood-based products, offers a compelling case. With a gross profit margin of 64.52% as of March 2025 and net income of NOK 255 million in Q2 2025, Borregaard trades at a P/E of 14x, significantly below its U.S. peers in the sector. Recent insider purchases, such as Tove Andersen's acquisition of 2,000 shares, underscore management's confidence in the company's ability to navigate external borrowing risks while capitalizing on rising demand for sustainable materials.

Capital Flight from U.S. Large-Cap Assets

The Trump administration's tariff policies have accelerated a shift in global capital flows. U.S. large-cap stocks, which had dominated investor portfolios in early 2025, now face valuation headwinds as concerns over long-term sustainability grow. The S&P 500's forward P/E of 30x, while historically elevated, reflects a market increasingly disconnected from broader economic realities. Meanwhile, European small-cap indices trade at multi-year lows relative to large-cap benchmarks, creating a stark asymmetry in risk-reward profiles.

This reallocation is not merely speculative. Germany's decision to relax its debt brake and boost infrastructure spending has injected momentum into domestically oriented sectors. Hanza (HANZ.ST), a Swedish manufacturing solutions provider, exemplifies this trend. With Q2 2025 sales rising to SEK 1.5 billion (up from SEK 1.2 billion in 2024) and net income surging to SEK 52 million from SEK 6 million, Hanza's 34% annual earnings growth is a testament to the resilience of small-cap firms in Germany's industrial heartland.

Strategic Considerations for Investors

While European small-cap equities offer attractive entry points, their performance is contingent on macroeconomic and political variables. Germany's economic slowdown and political uncertainty in France remain risks, but these are largely priced into current valuations. Investors should prioritize companies with strong balance sheets, insider confidence, and exposure to onshoring-driven sectors. For example, firms in the industrial and materials sectors, which are less reliant on global supply chains, are better positioned to withstand tariff volatility.

Monetary policy will also play a critical role. The ECB's rate-cutting cycle, if sustained, will further reduce borrowing costs for small-cap firms, enhancing their ability to invest in growth. This is particularly relevant for companies like Borregaard, which rely on external financing to fund expansion.

Conclusion: A Hedge Against Uncertainty

In a world where trade wars and geopolitical tensions dominate headlines, European small-cap equities present a rare combination of undervaluation, sectoral resilience, and structural support. They serve as both a hedge against Trump-era tariff volatility and a beneficiary of capital flows fleeing overvalued U.S. assets. For investors seeking diversification and long-term growth, the time to act is now. However, due diligence remains paramount: focus on firms with robust fundamentals, insider alignment, and a clear path to earnings growth.

In the end, markets thrive on asymmetry. European small-caps, undervalued and overlooked, may yet prove to be the most compelling investment opportunity of the year.