After too long in the doldrums, smaller UK companies are outperforming again. Rathbones UK Opportunities Fund Manager Alexandra Jackson explains why she expects this comeback to stick around.
Recent months are a reminder that market dislocations — especially those rooted in politics rather than fundamentals — can create opportunities for the patient and the nimble.
After monopolising investment returns for years, the attractions of the US equity market may be starting to wane. Investors seem to be questioning how much exposure they want to US stocks given President Donald Trump’s apparent willingness to ignore accepted norms around trade policy, diplomatic ties and fiscal surety.
As some capital once allocated to the US has taken fright, windows have been opening up closer to home.
Quietly, UK mid-caps (our preferred hunting ground) have been outperforming. The FTSE 350 has comfortably outpaced the major US indices in sterling terms in over the last three months. That’s a notable shift given the prevailing narrative in recent years that the UK market, and smaller caps especially, have been structurally overlooked. There’s still plenty of ground to make up, but the last few months have offered a glimpse of the potential.
UK assets in general are getting more of an airing as the UK political scene looks like a beacon of relative stability compared with other areas. As President Trump has been burning bridges with America’s trading partners, the UK has been beavering away to build them. As well as its deal with the US that removes punitive tariffs on UK car exporters, the UK has signed a major free trade agreement with India and secured the most significant reset of trade ties with the EU since Brexit.
All this bodes well for investor sentiment toward the UK. As one of my colleagues wrote recently: “Investors prefer a suboptimal certainty over an uncertain future when allocating risk.” The UK may not be optimal, but it is cheap and increasingly cheerful.
Notwithstanding April’s disappointing GDP data, the UK economy has been holding up reasonably well. Retail sales have picked up and high savings rates imply consumers have further spending power. The jobs market is cooling a bit, but pay is still rising faster than the rate of inflation.
Living in a small world?
The macroeconomic appears to be aligning at the stern for mid-cap UK companies in particular. Strong sterling and falling interest rates are especially positive for this part of the market. The former should help those smaller UK businesses that sell mainly at home because it increases the buying power of UK households and companies. It should also assuage foreign investors who may be leery of losing money on sterling, which has made a habit of shedding value in recent years. And the Bank of England’s continued rate cuts will loosen up financing for small and mid-caps and encourage more investment, hopefully boosting sales and business efficiency in the future.
All this, alongside UK mid-caps’ generally low starting valuations and strong earnings growth, have proved the springboard for a very big bounce-back. The FTSE 250 has raced ahead of the FTSE 100’s gains; it’s up by 15.01% over the last three months compared with the FTSE 100’s 9.36% rise. That outperformance looks particularly powerful when you take into account that the rise in passive investing means that money allocated passively to the UK market will have poured into the largest stocks. But they’ve performed much less strongly than their smaller brethren.
Is this the start of a global reappraisal of the value on offer from great British businesses at very cheap prices? That value has long been evident in continued corporate share buybacks and takeover bids from private equity and corporate buyers. It looks like we’re starting to see it being recognised more widely. As the chart below shows, stock market analysts are expecting UK small and mid-caps to trounce the biggest UK stocks earnings-wise.
Source: Panmure Liberum, Datastream
All this gives us more confidence in the outlook for UK mid-caps from than we’ve had in a long while.
Main image: paul-marlow-46Tg56viOUg-unsplash
