UK investors have begun to tire of safe-haven plays focused on large-cap stocks. Market watchers s...
UK investors have begun to tire of safe-haven plays focused on large-cap stocks.
Market watchers say little value remains at the top end and with economic recovery beckoning, the upside potential of small and mid-cap stocks is becoming more apparent.
Perpetual Income and Growth investment trust manager Mark Barnett says he is more negative on the mega caps ' the top half of the FTSE 100 ' than any other area of the market.
'While they are important in terms of where the index is moving week by week, they are not that interesting to me and they have not been for a while,' he says.
'For choice I would still say mid-caps are the place to be hunting, but for cheapness I'm finding a lot in the bottom half of the FTSE 100 as well. Small caps also look very cheap and there are some interesting opportunities down there.
'A lot of the mid-caps have been ignored and therefore there are some interesting stories that remain cheap. People have been focusing solely on the FTSE and as a result of the fund flows and the way the money has been managed, mid-caps get forgotten about and value appears.'
Barnett says the smaller stocks tend to get hit harder during a downturn because of their illiquidity, but the potential for gains on the other side of the cycle is also larger.
Henderson director of research and strategy Rupert Carnegie says: 'If we get a rally, we'll probably see people doing better in tech and perhaps we'll see some movement away from industrial cyclicals toward tech stocks.'
The decline of the passive style which many investors adopted during the bull run has also given way to a more active style that encourages investors to hunt for buy targets.
'Passive management tended to favour the very large stocks at the expense of the very small stocks, and I think that process has probably reversed to some extent. There was a positive bias towards large caps which has now been reduced,' Carnegie says.
And the trend is not exclusive to the UK, with Europe as a whole showing evidence of outperformance by small caps. From September 2001 to the end of June 2002, the HSBC Small Companies Index has outperformed its large-cap peer, the MSCI Europe Index, by 5%.
Andrew Spencer, head of European equities at JP Morgan Fleming, says Europe's low inflation and interest rates, coupled with stronger exports boosting growth prospects, are conducive to more cyclically-based small-cap stocks outstripping their large-cap peers.
Smaller European companies have been trading at a discount to large caps since the mid-1990s, with price-to-earnings ratios directly related to market cap, Spencer says. Data shows European large caps trading on 16 times 2002 earnings compared to small caps on 14.3 times, he says.
But the growth outlook for European small caps is positive, with IBES data showing small-cap earnings per share (EPS) growth at 14.5% compared to 8.3% for large caps.
'Although the actual rate of growth for each market cap group may change over the course of the year, we believe this will remain intact,' Spencer says.
Mid and small caps have more upside potential.
Small-cap cyclicals to outperform on upturn.
Small caps have higher EPS than large caps..