Small and mid caps will continue to outperform as the FTSE 100 remains unable to break through the 5...
Small and mid caps will continue to outperform as the FTSE 100 remains unable to break through the 5,400 barrier and is still, according to many, overbought.
The cyclical-heavy small and mid cap indices have greater exposure to these outperforming areas of the market than their large cap counterparts and look set to continue their outperformance long into the year.
The FTSE 100 has now made little headway for the past two months, trading within a narrow range, as the large cap index struggles to work through the overbought position it advanced to at the end of last year.
Michael Lenhoff, chief economist at Gerrard, says small and mid caps have outperformed on the back of the asset classes' sectoral make-up.
Lenhoff says: 'Both the mid and smaller cap indices are continuing to fare rather better than the large cap index. This principally reflects the greater exposure of the former, both to cyclical- and domestically-driven areas of the market.'
The FTSE 100 is proving constrained by its structural composition, Lenhoff adds. The index is dominated by financials, pharmaceuticals, oil and telecoms sectors, which respond positively to different stimuli and are at times negatively correlated. For example, while low interest rates will help debt-laden telecoms companies, banks suffer increased margin pressures, and this diversity in the requisite drivers needed to engender recovery has inhibited large caps' performance as a whole.
He notes: 'A large proportion of the FTSE 100's market cap is non-cyclical. We estimate this is somewhere in excess of 40% compared with the much smaller non-cyclical component of the FTSE 250. If a US-led recovery is on the way, as some recent evidence now suggests, the higher non-cyclical component will affect the FTSE 100's relative performance. The FTSE 250 has twice the weighting in areas geared directly to the cycle than the FTSE 100.'
The FTSE 250 has three times the FTSE 100's level of exposure to cyclical services. The sector has been among the top performing areas of the market over the last quarter.
Lenhoff says: 'Market leadership of the past months has very definitely favoured the mid-cap index and, if the US recovery arrives on schedule and the limited evidence puts the start in the second quarter, the outperformance could be sustained.'
Graham Secker, an analyst at Morgan Stanley, says consumer cyclicals are approaching their peak following recent outperformance and he is now favouring industrial cyclicals.
Secker says: 'Post this strong performance, we believe that investors should take profits in these sectors and continue to increase their exposure to industrial cyclicals.'
In accordance with this strategy, Secker is rotating out of general retailers and hotels, restaurants and leisure and moving overweight commercial services and transport.
This move is supported by an impending US recovery and inventory cycles reaching a trough, while industrial cyclicals also remain cheaper than their consumer counterparts, as well as by historic valuations.
Transport stocks in particular are due a rally, he adds. The sector has underperformed the market by 3% since the trough of 21 September, despite its economic sensitivity. As well as offering a proxy for global markets, transport stocks also offer possible corporate action stories, Secker says.
Small and mid caps outperforming.
Cyclicals posting strong growth.
US recovery is imminent.
FTSE 100 trading sideways.
Consumer cyclicals reaching full valuations.
Large caps underperforming.
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