Overlooked opportunities in mid-caps
I’m sure most people have heard of middle child syndrome – some have no doubt experienced it...
Joe Biden marked his first 100 days as president this week – 100 days of “rescue and renewal”, according to his Twitter account.
And in those 100 days he has enjoyed a number of successes: the US now has more people vaccinated than any other country, with anyone over the age of 16 in some States now able to simply walk into a centre and get the jab.
He has re-joined the Paris Agreement to tackle climate change, had an almost $2 trillion rescue package agreed, sent $1,400 to 85% of all American households and the economy has created 1.3 million jobs – more in the first 100 days than any other president on record.
The S&P 500 is also at an all-time high and the economy is enjoying resurgent growth. But will this boom in economic activity cause trouble in the coming months?
James Ashley, an economist at Goldman Sachs Asset Management, told us this week: “In the next couple of months I think there is a real possibility that US inflation will hit 4%. The market could easily react to this and we could see fixed income prices fall and equities wobble.
“I don’t think inflation will stay that high for long though, and the one area we have yet to see it come through is in wages. By year end it could be back at about 2%. But there I think it will stay for a while and will be more of a challenge than many have been expecting.
“Longer-term, I think deflationary forces will prevail. The rapid growth and adoption of technology and the aging population are still secular trends.
“Over the next couple of quarters I think we will experience very strong growth. But from 2023-24 onwards, it’s likely that growth will once again slow, and inflation will come back down. For the next 12-18 months value strategies could do well, then I think growth strategies will come back into play.
Bob Kaynor, manager of Schroder US Mid Cap fund, agrees inflation could run hot for a while. “I wouldn’t be surprised if inflation got that high in the short term,” he said. “The management of pretty much very company we talk to say that they are facing inflationary pressures and their biggest concern is whether they will have the ability to pass this on to the consumer in the second half of the year.
“We’ve had supply chain disruption, logistics challenges across the globe and agriculture, metals etc have seen their prices rise. Inflation is everywhere. The only place it is missing is in wages and, ultimately, that’s the only area of inflation the Fed will respond to.”
Steve Kelly, manager of AXA Framlington American Growth, says March was very challenging due to the rotation into cyclicals. “The combination of huge stimulus packages, the reopening of the economy, a very strong consumer and pent-up demand, friction in supply chains and low inventories have all created inflation,” he said. “And as growth has become more common across the economy, so growth stocks have suffered. The question now is whether this will continue.
“In the short term inflation is inevitable due to the base effect of a year ago. It could get close to 4% in the next 3-4 months and come back down to just over 2%, which is the Fed’s target. This is normal in the reflation stage of a cycle – you get inflation spikes.
“But we’d need much higher inflation and interest rates for there to be a structural change in leadership in my view. The last time there was a prolonged value cycle was in 2003-2007, when commodities were booming, banks were leveraging up and we had synchronised strong global growth. I think the likes of China and Europe would struggle to grow at the same rate today they did then though. I think there are headwinds to that scenario.”
While some of the big mega-cap growth stocks may struggle for a while, small caps may do well as they historically outperform during bouts of economic acceleration.
The only risk would be if inflation does go through to wages, because small caps are two times more labour intensive than large caps. But for now, the outlook looks positive and, according to Bank of America, small caps remain inexpensive compared with large caps. “They trade at a 12% discount to large caps when historically they’ve traded at a 3% average premium,” a spokesperson said.
Artemis US Smaller Companies
While stock selection is paramount on this fund, the overall shape will reflect the manager’s view of the US economy. Investing mainly in US small caps, but also with a tilt to mid-caps, Cormac Weldon uses multiple sources of information to generate ideas and leads one of very few US equity teams that have consistently been able to add value over many years in the hard-to-beat US market.
T. Rowe Price US Smaller Companies
This fund differs from the usual T. Rowe Price mould in that it is a more balanced core portfolio, with value names in addition to the usual growth focus. The manager looks for opportunities in the small and mid-cap space, to build a diverse portfolio of the best ideas from the vast analyst resource at his disposal. The manager will allow his winners to run as long as he still believes there is a return opportunity.
Schroder US Mid Cap
Run out of New York, this fund’s objective is to provide capital growth, primarily through investment in equity securities of small- and mid-cap US companies. To diversify the portfolio, the team has three sources of stock returns: ‘steady eddies’ act as ballast in the portfolio; ‘mispriced growth’ are stocks where Bob feels the market has not fully understood the company’s earnings potential; and ‘recovery-type’ situations.