Strategic Positioning of International Small-Cap Equities Amid Macroeconomic Normalization in Q3 2025

The global macroeconomic landscape in Q3 2025 is marked by a delicate balancing act. Central banks are navigating the dual challenges of inflation moderation and growth preservation, while trade tensions and policy shifts create both headwinds and opportunities for asset classes. Against this backdrop, international small-cap equities have emerged as a compelling strategic play, driven by favorable valuations, sectoral momentum, and macroeconomic tailwinds.

Macroeconomic Normalization: A Mixed Picture

Global GDP growth for 2025 is now projected at 2.42%, a modest upward revision from earlier forecasts, fueled by improved financial conditions and front-loading investments ahead of U.S. tariff implementations, according to the Global Macroeconomic Outlook Report, Q3 2025 - Declining. However, regional disparities persist. The Americas, Asia-Pacific, and Europe have seen growth forecasts revised higher, while the Middle East and Africa face downward adjustments. Central banks, including the European Central Bank (ECB), have aggressively cut rates-lowering the ECB's policy rate to 2.15% in June 2025-while the U.S. Federal Reserve has maintained its rate since late 2024, as noted in the same Global Macroeconomic Outlook Report.

Inflation, meanwhile, is trending downward globally, with expectations of a decline from 6.5% in 2024 to 4.1% in 2025, supported by lower energy prices and cooling demand, according to Euromonitor's Q3 2025 global economic forecast. The U.S. remains an outlier, with inflation projected to rise to 3.0% due to new tariffs and exhausted front-loading import activity, per the same Euromonitor forecast. These divergences underscore the uneven nature of macroeconomic normalization, creating asymmetric risks and opportunities across asset classes.

International Small-Cap Equities: A Strategic Sweet Spot

International small-cap equities have thrived in this environment. Non-U.S. markets and emerging economies delivered double-digit returns in Q3 2025, outperforming U.S. counterparts, as highlighted in the Global Macroeconomic Outlook Report, Q3 2025 - Declining. Key drivers include a weaker U.S. dollar, which boosted international assets, and progress in U.S.-China trade talks, which reduced geopolitical uncertainty cited in that same report. Additionally, global corporate earnings-particularly in the U.S.-remained robust, and central bank easing, including the Fed's September rate cut, provided further tailwinds, according to the Morningstar review.

Valuation metrics reinforce the case for small-caps. The Russell 2000, a proxy for U.S. small-caps, traded at a discount to large-cap growth stocks, with forward earnings multiples below historical averages, as noted in the "Undervalued Darlings" piece. This suggests undervaluation relative to peers, a trend mirrored in international markets. Investors have increasingly rotated into small-cap and value stocks, anticipating improved earnings and easing interest rates, the "Undervalued Darlings" piece also explains.

Sectoral Trends and Macroeconomic Synergies

Sectoral performance in Q3 2025 highlighted divergent dynamics. Industrials, information technology, and financials led gains, reflecting demand for capital goods, digital transformation, and the benefits of lower interest rates, per the Morningstar review. Conversely, energy and healthcare lagged, with energy underperforming due to lower commodity prices and healthcare facing regulatory and cost pressures.

The U.S. economy's resilience-marked by solid GDP growth and consumer spending-has supported global risk appetite, even as inflation remains a concern, as discussed in Morningstar's analysis. Central banks' policy adjustments, including the Fed's September rate cut, signal a pivot toward normalization, which historically favors small-cap equities due to their sensitivity to economic cycles and rate changes, according to the Twelve Points review.

Risks and the Road Ahead

While the current environment is favorable, risks loom. The U.S. tariff policy, though partially offset by front-loading and exemptions, has weakened consumer and business sentiment in G7 and G20 economies, as documented in the Global Macroeconomic Outlook Report, Q3 2025 - Declining. The WTO's revised global merchandise trade growth forecast of 0.9% for 2025, though an improvement, remains below pre-tariff estimates of 2.7%, a point also raised in that report. Looking ahead, further tariff hikes could reduce global output by an additional 0.3 percentage points in 2026, a scenario outlined in the Twelve Points review.

Conclusion: A Case for Strategic Allocation

International small-cap equities are well-positioned to benefit from the ongoing normalization of global macroeconomic conditions. Their outperformance in Q3 2025, driven by favorable valuations, sectoral momentum, and policy tailwinds, underscores their strategic appeal. However, investors must remain vigilant to trade-related risks and regional divergences. For those seeking exposure to growth in a low-valuation environment, international small-caps offer a compelling asymmetry: upside potential from normalization and downside protection from undervaluation.