Low interest rates and good valuations make for an attractive UK small-cap market but risks remain ...
Low interest rates and good valuations make for an attractive UK small-cap market but risks remain in the continued strength of the consumer.
Kenny Watson, investment manager for UK smaller companies at Britannic Asset Management, says small-cap stocks have outperformed large caps on a year-to-date basis, primarily because the bear market has pulled down FTSE 100 stocks.
He is currently favouring smaller companies because their low P/E ratings provide better value than other sectors, while the yields on offer stack up well against the fixed interest sector.
Head of UK smaller companies at Invesco Perpetual, Andy Crossley, agrees. 'There are some strong valuations, giving a solid argument for small-cap equities,' he says.
'Looking at yields compared to alternative assets such as cash and bonds, they are very cheap. Now is a good time to commit to the market but investors should expect to look for a return in around three to five years time.'
Watson expects large-cap stocks to rally once the Iraqi situation is resolved. Hopefully, he says, smaller companies will rally behind the large firms but there is a risk they could get left behind in a post-war rally.
Crossley says venture capitalists may become key buyers of smaller companies as such stocks can deliver the kind of returns they require. This could be the catalyst needed to turn the market around, he suggests.
Watson is optimistic about the UK economy in 2003. 'It appears to be more robust than some of its European neighbours, where there is little economic growth,' he says. 'By their nature, smaller companies do well because of more of a domestic bias. While there may be a slight slowdown in consumer spending, I feel the consumer is not going to fall off a cliff, with interest rates and unemployment low.'
Crossley is more bearish about the UK consumer. He feels the UK economy will slow more than the general consensus allows for, adding that while current economic data is in line with last year's estimates, it is only because those forecasts were reduced, something yet to happen for 2003 estimates.
'The consumer does not have to draw back far to have a big impact,' he says. 'If, for example, 2003 showed overall growth of 2%, it could cause mayhem in certain sectors. Other difficulties include volatility caused by the geopolitical situation, with a possible war in Iraq.'
Crossley says the key to the small-cap market is stock selection. He looks for stocks that are economically sensitive or that have long-term contracts.
Both Crossley and Watson are optimistic about the housing and insurance sectors. Crossley feels the housebuilding market has great defensive qualities because of already-low valuations.
Watson says the insurance industry looks good because there is a favourable underwriting environment as insurance premiums are going up.
'We are underweight media mainly because of the reduction in advertising and the lack of corporate media-related spending but we are overweight oil because of attractive valuations on high oil prices,' he adds.
Crossley is also bullish on the oil sector as the prices are high and he does not believe they will come down as the sector has good fundamentals.
Interest rates at low level.
P/E ratios look like good value.
Attractive dividend yields relative to cash.
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