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Small-cap equities lead the recovery, but caution is warranted

Timely insights from portfolio managers and industry experts on key financial, economic and political issues.

The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Eaton Vance disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Eaton Vance are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Eaton Vance strategy. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness.

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      By Aidan FarrellDirector of Global Small Cap Equity, Eaton Vance Advisers International Ltd.

      Boston - Eaton Vance and its affiliates seek to actively capitalize on opportunities presented by volatile investor sentiment, while ensuring that the portfolio risk profile remains appropriate for the specific strategy. The following are excerpts from a recent conversation with Aidan Farrell, Director of Global Small Cap Equity, Eaton Vance Global Advisors Limited and Calvert Research and Management.

      What we are seeing: It's been roughly two months since the equity markets started staging a recovery from the dramatic falls of late February and March. While it's been all but impossible to avoid the barrage of negative headlines ever since — either in relation to the tragic human toll of the pandemic or associated hits to the global economy — equity markets have nevertheless continued to gain ground. Optimism has been drawn from the large-scale fiscal and monetary responses and clear signs that measures to control the spread of the virus are working. Initial steps to ease at-home and business restrictions and set many global economies on the path of some sort of normalization have also led markets higher. It's worth noting the small cap indexes have led in the recovery.

      Despite the equity market's impressive rebound, we believe the environment remains uncertain in the near term and think it is wise to remain cautious. While significant progress has been made in combating the virus, and supporting the global economy through policy measures, the future path of the virus remains uncertain as is the ultimate impact on consumer and business confidence. As short-term financial support is slowly unwound in the months ahead, markets are likely to remain volatile, but therein lies opportunity.

      What we are doing: As mentioned in my last update, solid balance sheet strength is one of the key factors we evaluate in our quality, valuation and time (QVT) investment philosophy, and we adhere to that requirement. Our near-term focus has been to ensure our companies have adequate financial strength and liquidity to withstand this period of economic stress. We are devoting significant time and research to evaluate what behavioral or structural changes might emerge from this crisis. We are looking at potential changes both in the near term, as we await the development of an effective vaccine or treatment, and over the longer term, when this period of uncertainty is well and truly behind us.

      One somewhat surprising trend we've seen evidence of is a potential rise in the demand for automobiles as people continue to practice social distancing and may be reluctant to use busy public transport systems when returning to office locations. And, so-called staycations may add to demand for recreational vehicles. We may also see more flexible workspace and permanent work-from-home arrangements affecting various industries and office real estate. We believe working from home will be here to stay, and residential developments will have to take into account the need for separate home office space. There are myriad ways the nature of business and social interactions may shift, and we are delving deeply into this analysis.

      What we are watching: As we assess what factors are most critical to company durability and resilience during and after the pandemic, balance sheet strength comes to the fore. We are also continuing to analyze a number of short and long-term factors regarding a company's growth prospects, structural soundness and ability to withstand a constrained economy. Along with this, as mentioned, we are observing trends and listening to anecdotal stories to help us assess what new directions and social practices may shape the future of businesses and our lives.

      Final word: Only time will tell what behavioral or structural changes will occur as a result of the public health and associated economic crisis that has consumed our world in 2020. As investors, it is our job to consider these changes and assess whether they represent opportunities or threats to various sectors and companies.