European equities have been in focus since approximately the second half of 2013 and into early 2014. After the global financial crisis of 2008–09, it was easy to find reasons to express negative viewpoints about Europe. However, as is so often the case in equity markets, the crisis occurred, valuations adjusted downward, and then performance started to turn around.

When Did Performance Start to Turn Around?

Whether one looks at the performance of the S&P Europe 350 Index (large-cap European equities) or the MSCI Europe Small Cap Index (small-cap European equities), the notable shift in performance from downward/flat to an upward trend occurred in June of 2012.1 It’s interesting to us that the performance shift occurred approximately one year prior to the European equity markets coming into serious focus for investors.

Being Economically Sensitive

Some of the best times, historically speaking, to consider different equity markets have been points of inflection—when the characteristics of a market shift in such a way as to bring new information to light and function as a catalyst for investors to change their thinking. In the second half of 2013, discussions about Europe’s economic growth prospects improved. This occurred at the same time as economic growth expectations in emerging markets were largely adjusted downward. People started having more confidence in Europe not only because its growth prospects were improving but also because, judged against the other regional allocation options, Europe was improving its stature and started looking better as a potential allocation option.

Positioning oneself to take the greatest potential advantage of this shift involves two elements, in our view:

Small Caps: In regional equity markets around the world, small-cap companies are often the most nimble. As economic growth expectations improve, they are the fastest in adjusting their business models to take advantage of the new situation. They also tend to have a greater share of their revenue streams coming from their local markets than do large-cap, global exporters.

Industrials & Consumer Discretionary: These are some of the sectors within small-cap stocks that are the most highly leveraged to changing economic growth prospects. Consumer Discretionary firms can quickly respond to the uptick in consumption of discretionary items as consumers feel better about their future economic prospects. Industrials can increase their capital spending initiatives as they prepare for the increased demand for their outputs from their customer bases.

The WisdomTree Europe SmallCap Dividend Index Was Strongly Exposed to These Elements

Between June 29, 2012, and December 31, 2013, the WisdomTree Europe SmallCap Dividend Index (WTESC) had an average exposure of greater than 40% to these two sectors (Consumer Discretionary and Industrials). WTESC also has its annual rebalance in June of each year to refocus on the small-cap segment of the dividend-paying equity market in Europe.

Did Exposure Translate to Performance?

Below, due to the availability of data, we note the performance of WTESC against the performance of the S&P Europe 350 Index, an index designed to measure the performance of large-cap European companies.

WTESC Captured the Trend of Improving Equity Performance in Europe (6/29/2012–12/31/2013)