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Small caps can tell us a lot about the market mood

Please see below for one of AJ Bell’s latest Investment Insight articles, received by us yesterday 28/03/2021:

Small cap stocks are perceived to be riskier than their large cap counterparts and with good reason. As such, they can be used to judge wider market risk appetite – if small caps are rolling higher, we are likely to be in a bull market. If they are falling, we could be shifting to a bear market.

In general, small caps tend to be younger firms that are still developing. They are potentially more dependent upon certain key products or services, a narrower range of clients and even key executives.

Their finances might not be as robust as large caps and they are more exposed to an economic downturn, especially as they are less likely to have a global presence and be more reliant on domestic markets.

The UK’s FTSE Small Cap index currently trades at record highs, while the FTSE AIM All-Share stands near 20-year peaks. The latter is still well below its technology-crazed highs of 1999-2000. Equally, they are more geared into any local economic upturn.

America’s Russell 2000 index, the main small cap benchmark in the US, is up 16% this year and by 116% over the past 12 months. That beats the Dow Jones Industrials, S&P 500 and NASDAQ Composite hands down on both counts.

In fact, the Russell 2000 now trades near its all-time highs, having gone bananas since last March’s low. Such a strong performance suggests that investors are in ‘risk-on’ mode and pricing in a strong economic recovery for good measure.

Rising Prices

One data point which does not sit so easily with the US small cap surge is the slight pullback in America’s monthly NFIB smaller businesses sentiment survey, which still stands 12 percentage points below its peak of summer 2018.

This indicator must be watched in case it does not pick up speed as America’s vaccination programme continues and lockdowns are eased. Further weakness could suggest the recovery might not be everything markets currently expect.

Equally, inflation-watchers will be intrigued by the NFIB’s sub-indices on prices. In particular, the balance between firms that are reporting higher rather than lower prices for their goods and services, and especially the shift in mix towards smaller companies that are planning price rises rather than price cuts.

If both trends continue, then bond markets could just be right in fearing that an inflationary boom is upon us.

Interest rates on the move

The number of interest rate rises continues to gather pace on a global basis. Last month there had already been five hikes this year in borrowing costs, in Zambia, Venezuela, Mozambique, Tajikistan and Armenia. There have now been six more – Kyrgyzstan, Georgia, Ukraine, Brazil, Russia and Turkey.

The 11 rate increases we’ve seen year to date is already two more than in the whole of 2020.

In contrast, the US Federal Reserve is content to sit on its hands despite what is happening elsewhere. Chair Jerome Powell continues to reaffirm the American central bank’s commitment to running its quantitative easing scheme at $120 billion a month, while any plans to increase interest rates from their record lows seem to be on hold until 2024.

Powell does not seem concerned about inflation and is seemingly willing to risk its resurgence to ensure that the economy gets back on track in the wake of the pandemic.

Yet financial markets are still taking the view that a strong upturn is coming, because US government bond prices are currently going down, and yields are going up, regardless of what the Fed says. That is a huge change from the last decade or so, when bond and stock markets have been happy to slavishly take their lead from central bank policy announcements.

Please continue to utilise these blogs and expert insights to keep your own holistic view of the market up to date.

Keep safe and well.

Paul Green DipFA

29/03/2021

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FTSE primed to play catch-up after lagging US stocks

Please see below for the latest market update from AJ Bell: 

The pound losing its recent strength and oil stocks responding to a higher commodity price could boost the index

Investors in UK stocks have been looking jealously (or frustratingly) at the performance of the US markets and wondering why the FTSE 100 has stubbornly refused to rebound as fast.

Year to date, the S&P 500 is up nearly 5% and the Nasdaq is up 25% whereas the FTSE 100 is down nearly 19%, all on a total return basis.

The answer is simple – the UK stock market is very under-represented by tech stocks which is the sector that has driven US markets this year.

The UK is also heavily weighted towards banks and energy stocks, two of the worst performing sectors in 2020.

The former has been depressed by a drop in interest rates, rising concerns over potential bad debts as consumers and companies struggle as a result of the pandemic, and the suspension of dividends.

The energy sector has been hit by a big decline in the oil price and a reduction in dividends making it less appealing to income investors.

Yet are we about to see a reversal of fortunes?

Recent strength in the pound versus the US dollar will have worked against the multitude of companies on the FTSE 100 which earn in the latter currency, but whose share price is quoted in the former. Those dollar earnings will be worth less when translated into sterling.

Approximately three quarters of the FTSE 100’s earnings come from outside the UK, so foreign exchange rates really matter to the performance of the index.

Bank of America this month turned bullish on UK equities, partly because it expects the pound to weaken again on the back of rising no-deal Brexit risks. If sterling weakens then dollar revenues, once converted back into sterling, are worth more.

The bank also believes the energy sector should catch up with recent strength in the oil price, thereby giving another support to the FTSE 100 with oil producers Royal Dutch Shell (RDSB) and BP (BP.) being major constituents of the index.

Such predictions would suggest investors are right to remain hopeful for better returns from the FTSE. However, performance is still dependent on economic activity picking up around the world and unfortunately there are some mixed signals.

Stock markets last week took a tumble after the US central bank expressed concern that the pandemic could greatly impact the US economy in the medium term.

The latest Eurozone PMIs disappointed while the US and China’s recent figures have been more upbeat. These are various indices which show confidence levels from purchasing managers and which are a good economic bellwether.

Against this backdrop, the latest Bank of America survey of fund managers shows that institutional investors remain bullish about markets despite a difficult backdrop.

It’s an ever-moving feast and investors would be best served by not fiddling with their portfolios in response to every bit of economic data that comes out. Stay diversified and accept that there may well be some parts of your portfolio lagging others – it’s just the nature of investing.

A brief but concise summary like this is an efficient way of keeping your views of the markets up to date.

If you read the previous blog you can see Jupiter’s Fund Manager, UK All Cap, James Bowmaker’s views on the FTSE too.

Take care and keep well.

Paul Green

28/08/2020