Overlooked opportunities in mid-caps
I’m sure most people have heard of middle child syndrome – some have no doubt experienced it...
So we made the most of long term co-manager, and soon-to-be-successor, Bob Kaynor’s flying visit to London to ask the questions we all want answers to: what’s the government shutdown all about and is the bull run over?
We are in uncharted territory in terms of the number of days the government has been shutdown, but it’s worth remembering that staff have only just had the first missed pay cheque – therefore the true impact is yet to be determined.
There are clearly some industries that are more exposed than others, such as airlines. Importantly though, the US consumer is in a good place. There is low unemployment, good wage growth and the benefits of tax reform to the lower-end consumer have not come through yet. So while the impact has yet to be felt, it will hit a place with relatively comfortable consumer backdrop, which offers good support.
Small cap tech has done well. Last year, the sector was basically flat, so in the end one of the better performers, relatively speaking. The profile is very different to large cap tech too – it’s not skewed towards just a couple of names. The sector is much more diversified in terms of number of companies and technologies, so can behave differently.
This did come through: we saw earnings and cash flow growth last year. The money they saved was spent on a combination of capital expenditure, share buy-backs and acquisitions. To a lesser extent, there was de-leveraging, but the level of this was disappointing – I would have hope for some more. The amount of share buy-backs was too much in my opinion too, and not beneficial for the long term.
In short, yes, though with a considerable ‘but’…
It is still possible to make favourable returns from US equities even if the environment isn’t as easy – the returns just won’t go up in a straight line as they have done recently. As Federal Reserve (the US central bank) policy and a China slowdown comes through to the market, there will be more volatility, so stock picking will be key.
I expect the growth of small and medium-sized US companies will be greater than that for larger companies over the next couple of years. Valuations are around average, while large caps are on the expensive side, and earnings growth is better even though small and mid-caps have been through a period of weaker performance.
Small caps were down 10-11% in 2018 compared with the S&P 500 (the US’s idex of 500 largest companies), which was pretty much flat over the 12 months. Therefore, we see a favourable backdrop, based on recent performance and superior earnings growth.