Smaller companies have enjoyed a period of steady, almost uninterrupted growth in 2005, continuing t...
Smaller companies have enjoyed a period of steady, almost uninterrupted growth in 2005, continuing the trend that has been in place for the past two years. Recent gains have come against a background of modest inflationary pressure, slowing UK economic growth, continuing corporate activity and hopes that the August interest rate cut will be followed by another before the end of the year.
Signs of an upturn in global economic growth have recently enabled cyclical areas of the market to enjoy renewed strength, with economic and market-sensitive sectors such as engineering and selective financials being key beneficiaries. With the crude price remaining above $60 on expectations that supply will fail to keep pace with demand, oil stocks have made strong progress, although in contrast defensive areas are performing less well as investors increase levels of cyclicality in their portfolios.
Overall global economic growth is being driven by the US, where the initial estimate of GDP for the second quarter was 3.4%, the ninth consecutive quarter in which growth has exceeded 3%. The recovery in Europe generally remains sluggish, although business confidence has picked up across the region and employment levels are showing modest improvements in both France and Germany.
In the UK, GDP growth will be below trend this year and the outlook for 2006 is also sluggish, with consumer spending likely to remain muted. However, the share price performance of smaller companies is being helped by interest rate optimism, improving corporate profitability and higher levels of mergers and acquisitions.
We are finding interesting opportunities in a range of sectors and expect stock selection rather than sector allocation to continue to be the key driver of relative returns through the remainder of the year. With slower economic growth, our focus is on those companies with strong market positioning and sound finances. Favoured areas currently include oils, with core portfolio holdings including Premier Oil and Burren Energy. Some companies within the support services sector look set to enjoy long term structural growth, with examples including social housing maintenance provider Mears Group, training company Carter & Carter and infrastructure maintenance company Mouchel Parkman.
In industrials, we hold a number of later cycle engineers, such as Charter and Bodycote, while there are also some interesting high-growth, modestly valued companies in the software sector, such as Torex Retail.
In contrast, we are less positive on general retailers, given that the consumer environment is likely to remain difficult; food producers, which continue to suffer from margin erosion; IT hardware, which is expensively rated with demanding forecasts; and housebuilders, which are encountering more difficult trading conditions.
Smaller companies growth has been almost uninterrupted in 2005
Overall economic growth driven by US.
Stock selection rather than sector allocation to be key driver of returns.
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