The cyclical stock bias within the FTSE Small Cap index has been the main driver of its recent outpe...
The cyclical stock bias within the FTSE Small Cap index has been the main driver of its recent outperformance.
Over three months to the end of June 2003, the small cap index has outperformed both the FTSE All-Share and the FTSE 100.
From the end of March to the end of June, the FTSE Small Cap has risen 29.10%, outperforming the All-Share, which was up 14.62%, and the FTSE 100, which had grown 12.52%.
Richard Wilmot, fund manager at Mellon, says following the large reduction in interest rates, the market is now anticipating a rebound in economic activity to occur in 12-18 months' time, and as a result investors are buying more cyclical stocks in anticipation. Wilmot said the bias towards cyclical stocks in the small cap index was the driver for its outperformance during the second quarter.
Due to the illiquidity of small caps, Wilmot adds it only takes a small amount of money to be transferred from large caps for the sector to rise.
He says: 'Small caps have also been doing well because there has been more M&A and corporate activity. One area that has seen a number of bids is the consumer sector.'
On a note of caution, Wilmot says a number of companies have been achieving their profit targets via cost cutting rather than through any top-line growth, so he argues there is little evidence the economy is actually improving as yet.
As a result, he believes there is a danger if the economy does not improve over the next six months, some of those that have gone up may start to look vulnerable.
Added to this, he says, over the past five to 10 years, many cyclical stocks performed well in the first half of the year and did less well in the third quarter as investors made a reassessment. As a result, share prices can often pull back.
Simon Bailey, fund manager at M&G Investments, notes one of the major factors behind the recent performance of small caps is that a number of bombed-out cyclical stocks like Spirent, WS Atkins and Corus all fell into the sector after their balance sheets became too stretched.
These stocks, says Bailey, all became oversold and as a result have bounced in the past three months, a large driver for the index as a whole.
He says: 'Investors are now more open to growth companies and to buying companies where there is more risk involved due to the outlook for decent growth going forward.' The overselling of companies, says Bailey, triggered a number of bid approaches from venture capitalists and other companies, which he argues demonstrates there is a lot of value in the area.
While Bailey is positive on the long-term outlook for smaller companies and their opportunity to add value, he admits they are economically sensitive and are not immune to the economic environment. He believes they will be volatile in the mid and short term.
Bailey adds valuations have reached their appropriate level, so in the short term there is not much room left for them to rise further.
FTSE Small Cap has risen 29% since March.
Investors now more open to taking risk.
Long-term small cap story remains sound.
Cowardly, boring or sensible
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