SCHE: Navigating Geopolitical Storms in Emerging Markets Small-Cap Equities

In an era defined by geopolitical turbulence and the slow unraveling of globalization, the S&P Emerging Markets Small Cap Select Equity (SCHE) ETF has emerged as both a lightning rod and a potential haven for investors seeking asymmetric returns. While small-cap emerging markets equities are often dismissed as volatile and speculative, a deeper analysis of historical performance during crises reveals a nuanced picture: these markets, though more susceptible to shocks, frequently rebound with vigor when fundamentals align. This article examines SCHE's resilience during pivotal geopolitical events and explores how deglobalization pressures may create unique valuation opportunities for patient investors.

Historical Resilience: Lessons from the 2019 and 2022 Crises

Emerging markets small-cap equities, as represented by SCHE, have historically exhibited a dual nature during geopolitical shocks. For instance, the 2019 drone strike on Saudi Aramco—a critical node in global energy markets—triggered a 3.1% single-day drop in the Tadawul All Share Index (TASI), a proxy for Gulf markets. While SCHE's direct exposure to Saudi Arabia is limited, the ripple effects of oil price spikes and regional instability disproportionately impacted smaller EM firms reliant on energy exports or trade with the Middle East. However, within 41 days, the index had recovered its losses, underscoring the rapid-fire nature of EM market corrections.

The 2022 Russia-Ukraine war further tested SCHE's mettle. Emerging markets small-cap equities initially fell by 12% in the war's first month, driven by panic over energy prices and supply chain disruptions. Yet, by mid-2023, the index had clawed back 8% of its losses, fueled by central bank interventions, energy market adjustments, and the resilience of non-energy sectors in countries like India and Indonesia. This pattern—sharp declines followed by swift recoveries—aligns with broader EM market behavior, where liquidity constraints and concentrated exposures amplify short-term volatility but also create buying opportunities for long-term investors.

Deglobalization and the New Supply Chain Paradigm

The past decade has seen a shift from globalization to “deglobalization,” with nations prioritizing supply chain resilience over cost efficiency. This trend has profound implications for SCHE. Small-cap EM firms, often operating in niche sectors or regional markets, are uniquely positioned to benefit from reshoring and friendshoring initiatives. For example, India's push to become a manufacturing hub for electronics and pharmaceuticals has boosted smaller firms in these sectors, many of which are included in SCHE. Similarly, Southeast Asian companies producing critical minerals for green energy transitions have gained traction as Western nations diversify away from China.

However, deglobalization also introduces risks. Smaller EM firms with limited diversification are more vulnerable to trade restrictions or sanctions. For instance, Ukrainian small-cap exporters faced near-total collapse in 2022 due to war-related disruptions. Yet, this volatility is not inherently negative. As the 2019 Saudi Aramco attack demonstrated, crises often expose undervalued opportunities in sectors like logistics, cybersecurity, and alternative energy—areas where EM small-cap firms are increasingly active.

Valuation Opportunities in a Fragmented World

The current geopolitical landscape has created a “buying window” for SCHE. Emerging markets small-cap equities trade at a 30% discount to their U.S. counterparts, a premium that has widened during periods of global uncertainty. This discount reflects both the perceived risks of EM markets and the underappreciated potential of smaller firms to adapt to shifting trade dynamics.

Consider the case of Indonesian nickel producers, which have surged in value as the U.S. and EU seek to reduce reliance on Chinese supply chains for EV batteries. These firms, many of which are small-cap, have seen their valuations multiply despite macroeconomic headwinds. Similarly, Brazilian agribusinesses have capitalized on the Russia-Ukraine war by filling gaps in global wheat and soybean markets, with their stock prices outperforming broader EM indices.

Strategic Considerations for Investors

For investors considering SCHE, the key lies in balancing risk and reward. While small-cap EM equities are inherently volatile, their historical performance during crises suggests that disciplined, long-term investors can capitalize on dislocations. Here are three strategic recommendations:

1. Sector Diversification: Focus on sectors with geopolitical tailwinds, such as renewable energy, critical minerals, and digital infrastructure. Avoid overexposure to energy-dependent or politically sensitive regions.
2. Active Hedging: Use currency and commodity hedges to mitigate macroeconomic risks, particularly in countries with unstable monetary policies.
3. Contrarian Timing: Buy during periods of acute geopolitical panic, as markets often overcorrect. For example, SCHE's 2022 low point coincided with a 14.4% one-year rebound in the S&P 500, illustrating the power of contrarian investing.

Conclusion

The S&P Emerging Markets Small Cap Select Equity ETF is not a risk-free investment, but it is a risk-reward asymmetry that deserves attention. As deglobalization reshapes trade and supply chains, small-cap EM firms are poised to play a pivotal role in the new economic order. By understanding historical patterns and leveraging valuation discounts, investors can position themselves to benefit from the resilience and adaptability of these markets. In a world where geopolitical storms are inevitable, SCHE offers a compass for navigating the turbulence—and a potential windfall for those who dare to look beyond the headlines.