As FTSE 100 hits all-time highs, it's time to take advantage of stocks and shares

Video  Link:

IBTimes UK: FTSE 100 Hits All-Time Highs, So Buy Some Stock Exposure

Stock market indices worldwide have been crashing through key psychological levels to new all-time highs: 7,000 on the FTSE 100, 5,000 on the technology-heavy Nasdaq index in the US and 12,000 on the key DAX index in Germany.

But most people have missed out on this market rally

While this stock market rally sounds very glamorous, one of the key features of the current run-up in stock markets worldwide is how few people in Europe have actually taken advantage.

Figure 1: Only 18% of UK, 13% of German Households Have Exposure to Shares

Source: Office for National Statistics, US Federal Reserve, Deutsches Aktieninstitut

Take the example of the UK: only 18% of households hold exposure to shares directly or indirectly via unit trusts or other funds (Figure 1). That means 82% of households have seen no direct benefit from the doubling in value of the FTSE 100 index since the early 2009 crisis lows.

In fact, matters are even worse in Germany, where only 13% of all households had any exposure to shares or equity funds of any sort.

And you may think the doubling in value of the FTSE 100 over six years is impressive. Well think again. The German DAX index of Germany's largest 30 stocks has risen from 3,600 in early 2009 (a similar level to the FTSE back then) to over 12,000 today, more than tripling in value over the same six years.

The 2008-09 financial crisis took its toll on stock market confidence

Clearly, the big hit to stock markets from the 2008 global financial crisis (when the FTSE 100 fell nearly 50%) has put many people off investing in stocks and shares, as we can see from the drop in value of unit trusts held in Isas from 2005 to 2008 (Figure 2).

Figure 2. Amount Invested in ISA-Based Funds 84%, When FTSE 100 100%

Source: Investment Association

Interestingly, the total value of funds held in Isas only rose 84% from the low in 2008 to the end of 2014, while the FTSE 100 doubled. Clearly, a lot of the money held in funds in Isas was not invested in shares but rather in other assets such as government bonds.

Yet again, more evidence that many investors have not taken full advantage of the current stock market rally.

Mostly about housing

So where is the net worth of UK households held? Unsurprisingly, given the strong rebound in the UK property market over the past few years, 42% is held in housing (both primary residences and second homes, plus buy-to-let; Figure 3). Meanwhile, 35% is held in private pensions and life insurance policies (including annuities). 

Figure 3. 77% of Household Wealth in Housing, Pensions and Life Insurance

Source: Office of National Statistics. Correct as of end-2013

And a full 16% of total household wealth is still held in cash savings, despite the historically low interest rates on offer. In stark contrast, only 7% of total household wealth is held directly in shares or unit trusts exposed to shares.

Time to build up your share exposure

These statistics serve to highlight most people have not benefited anything like as much as they could have from the rise in the FTSE's value. But it is never too late.

Looking today, I would make two observations. Firstly, Europe could be a good home for new share-based fund investments given the economic recovery under way and the consequent improvement in corporate profits. And secondly, one of the best low-cost ways to achieve this is through exchange-traded funds (ETFs), which are as easy to buy as any share and can be held in any self-select stocks and shares Isa.

Don't forget, time to fill up your Isa

Remember the limit for contributions to an Isa are £15,000 for the 2014-15, which ends on 5 April, two weeks from now. So if you haven't put much or even any money into a stocks and shares ISA, now could be a good time if you have any spare cash lying around earning a minimal rate of interest in a savings account.

A good ETF to buy to get exposure to the strong recovery in Continental Europe is the iShares MSCI Europe ex-UK UCITS ETF (code: IEUX), which is priced in pounds but gives exposure to the largest companies in France (21%), Germany (21%) and Switzerland (21%) within Europe.

VIdeo Slideshow: Global Strategy Weekly Review

Here I have recorded a 4-minute video slideshow of key trends
in financial markets over the last week: Please click on the video to watch

All the best, Edmund

November 2014 Investment Outlook Preparing for a Year-End Rally

Stock Markets Set Up For Continued Rally

The six weeks from the beginning of September through to mid-October inflicted substantial damage on all major stock markets barring China (Figure 1), with developed markets falling 5-11% and the MSCI Emerging Market index losing 11% over the period. 

1. All Stock Markets Fell from Start-Sept. Except China

Source: Bloomberg

Fears over the strength of the global economy have dominated, with sanctions impacting not only the Russian economy but also those in the Eurozone, including that of the export powerhouse that is Germany. As a result, business confidence in Europe has suffered, putting the brakes on business investment and condemning the Eurozone to a no-growth economy (Figure 2). 

2. German Business Confidence Takes a Big Hit

Source: Bloomberg

However, this quick stock market correction has not taken into account a number of more positive economic trends, including the positive impact of lower oil prices on global consumers. 

Oil Price Plunge Boosts Consumption

The Brent crude oil price has fallen $30 per barrel from mid-June peak to around $85 per barrel currently. Of course, this is bad news for oil exporting countries including OPEC members and Russia. But according to The Economist, if this oil price were maintained, then oil consumers would benefit by paying an oil bill some $1 trillion lower.

The positive effects of this are already starting to be seen through rising US consumer confidence, thanks to retail gasoline prices falling 17% since the end of June to $3.14/gallon now. This should feed through to US GDP growth, heading closer to 3% annual growth based on current encouraging trends in the ISM Manufacturing survey.  

Seasonal Effects Now Turn Positive

In addition, after a turbulent month of October, seasonal trends now turn more favourable from November until the end of April. Historically, the VIX volatility index has peaked in mid-October, and then fallen until Spring-time, a pattern that it is starting to repeat now after touching a 3-year peak of 26 this month (Figure 3).

 3. VIX Volatility Index Calming Down

Source: Bloomberg
    

Prefer Growth to Value: Technology, Healthcare

With the US Federal Reserve edging closer to the end of the current round of Quantitative Easing (QE), this is typically a time to favour Growth as an investment style over Value. 

From an economic point of view, the Technology sector is a growth sector that should benefit from two factors: 

1. The improving growth in business investment, particularly in IT hardware & software; and
2. Improving consumer confidence in the crucial Christmas buying season boosting demand for consumer electronics.

Healthcare is a second Growth sector that stands to benefit from the continued growth in healthcare demand from emerging market consumers, and also from the increasing penetration of US healthcare insurance coverage as a result of Obamacare.
     

4. Technology & Healthcare Lead

Source: Bloomberg
        

Where to Focus in November

Aside from remaining convinced that both Technology and Healthcare sectors can move higher still, I believe that global bond yields will remain low for the foreseeable future given the continued savings glut, with investors seemingly unwilling to commit to risky assets and preferring the safe havens of government bonds and even cash. 

But, given that the best predictor of future 10-year returns from government bonds is the current bond yield, the 2.3% on offer in 10-year US Treasuries and the 0.9% offered by German Bunds seems very unattractive, with low-volatility dividend growth stocks more attractive in sectors such as Insurance and even Real Estate.

Finally, the US dollar seems set to continue to strengthen against most other currencies,  given that the European Central Bank and Bank of Japan seems set to do whatever they can to weaken their currencies, while the US Fed is putting an end to QE (at least, for now).
    

5. US Dollar Can Still Recover a Long Way

Source: Bloomberg

IBT Video: No Need to Panic over Tumbling Stock Markets

To watch this International Business Times video interview with the UK editor George Pitcher, please click on the web link below:

Money-times-no-need-panic-over-tumbling-stock-markets

Why Do Punters Love AIM so much? Mid-Caps are so much better...

OK, so I am misleading you - in the title of this post, I ask the question "Why do punters love AIM so much?", when I know the answer. It is like lottery gambling, where you are hoping to strike it rich by unearthing a multi-bagger of an investment!

And clearly there have been some notable successes chalked up, like ASOS (LON:ASC) (before its recent travails) which has been a very impressive multi-bagger if you got in early on.

But for a "real" investor who does his or her own spadework and has a well-defined investment process that they use, does it make sense to invest much cash or time on AIM companies? Let's look at some very basic statistics:

Exhibit 1: Price Performance of UK Indices since the AIM 100 index
started in late 2005

In this chart, the black line is the benchmark FTSE-100 index, the soaring blue line the FTSE Mid 250 index, the green line the FTSE SmallCap ex investment trust index, and the purple line bringing up the rear is the FTSE AIM 100 index.

Looking at these 4 indices, it is apparent that the FTSE Mid 250 index has more than doubled since late 2005, while in contrast the AIM 100 index has nearly halved, with both large- and small-caps somewhere in the middle, both with relatively modest gains. That means a near four-fold difference in performance between mid-caps and AIM stocks over 9 years!

The basic point is this: the AIM market is NOT the same as the main LSE market - the listing rules are not anything like as stringent, and the failure rate for young companies is, as we all know, high. So the risks inherent in investing not just in stocks, but in AIM-listed stocks in particular, are clearly very high. This means that investors venturing into the murky AIM waters need to do even more due diligence in their research than they would for a larger, more established company which has a longer track record and typically more mature products and services. 

OK, I understand, you don't just want to invest in the largest, boring UK-listed companies like Vodafone (LON:VOD) and GlaxoSmithKline (LON:GSK), which in any case are arguably not very British as companies these days given their global footprints.  

What is interesting is even if you invested instead in the average UK stock within the MSCI UK index (a collection of FTSE 100, FTSE Mid 250 and the largest FTSE SmallCap stocks), you would still have done substantially better than the market-cap weighted FTSE 100 index!

Exhibit 2: Equal-Weight UK Index vs. FTSE 100, FTSE Mid 250 from 1999 on

While the FTSE Mid 250 index (in green) still did much better than the FTSE 100 index (yellow line), the equal-weight MSCI UK index still gave you a cumulative 81% price gain from 1999, as opposed to only 12% from the FTSE 100. Yes you would have gained slightly more in dividends from the large-caps, but nothing like enough to start bridging this enormous gulf in performance. 

Morals of this story:

1. The AIM market should come with a strongly-worded health warning, only experienced investors should venture in, and even then they should tread very carefully.
2. All other investors wanting to get exposure to UK stocks would be far better off investing in either the FTSE Mid 250 index (yes there are low-cost FTSE 250 index ETFs available from both iShares and Deutsche Bank's x-trackers), or in a broad range of UK stocks drawn from the FTSE 100, Mid 250 and SmallCap market segments, weighted in equal proportion in the final portfolio. Normally, 15-20 stocks should give a decent level of diversification.

- See more at: Stockopedia post

Warm Up on Polar Capital!

Polar Capital: A Good Time To Warm Up

Polar Capital (LON:POLR) is an asset manager, managing a selection of investment trusts (like the Polar Capital Technology Trust, PCT; and the Polar Capital Global Financials Trust, PCFT). They also manage a number of unit trusts and hedge funds, with their Assets Under Management (AUM) up to $13.6bn as of the end of June this year.  

Why I Like Asset Managers

I like asset managers for a number of reasons: 

1. Firstly, their business model tends to be asset-like, but highly profitable. 
2. Secondly, as a result of this they are often serial dividend payers and growers, and 
3. Thirdly, they also tend to hold net cash on their balance sheets, a good buffer to have against periodic stock market and economic downturns. 

They Should Benefit from Financial Repression

We remain mired in a strange economic scenario, where global economic growth is struggling and requires a very helping hand from central banks around the world, in the form of Zero Interest Rate Policies (ZIRPs) and Quantitative Easing (QE) programs. While these ultra-low interest rates have been manna from heaven from borrowers, they have been dreadful news for savers, with UK deposit savings rates falling year on year (Figure 1).

1. UK Deposit Rates Hit a New Historic Low

And yet, scarred no doubt by 2 stock market crashes since the year 2000, the average UK household has preferred to keep a large amount of savings in the form of cash, rather than any other higher-yielding investments like stocks and shares. This is a global trend; In the US and Germany, for example, cash held on deposit by households continues to hit new highs at over 0.4% of GDP (red line and right-hand scale on Figure 2), in spite of the five-year old stock market rally and the US S&P 500 index recently breaching the 2000 level. 

2. US Savers Keep Record Amounts in Cash

As these ultra-low interest rates on cash deposits remain, there will be added pressure over time on households to find better yields elsewhere, in other asset classes like stocks and bonds.

Right Now, Stocks Yield the Most

The Hunt for Yield should push investors towards stocks, given the already-depressed yields now available on government bonds; note that you now have to pay the German government in effect for them to keep your money for 1 year (Figure 3)! While the FTSE 100 index is due to pay out 3.7% this year...

3. Stocks Yield More than Bonds or Cash

So for asset managers like Polar Capital (LON:POLR) who specialise in stock-based funds or higher-yielding specialist areas like emerging market bonds, this should ensure positive inflows over the medium-term. 

Polar Capital: High Dividends, Backed By High Profitability and Cash on Balance Sheet

Running Polar Capital by the numbers reveals a number of strengths that attract me to the stock. Firstly, the dividend yield is high at 7.3% on a prospective basis (Figure 4), although Stockopedia registers an even higher 7.9% yield number. these compare very favourably to yields available elsewhere in the higher-yielding Asset Management sector. Moreover, this dividend has grown steadily from 4.5p for March 2010 to a forecast 30.8p for the fiscal year ending March 2015. 

4. US + UK Asset Managers' Dividend Yields

You might be concerned that Polar Capital's dividend cover ratio is only 1.1x, but there are a couple of further positives that should allay these dividend payment fears. 

Profitability, as measured by last year's Return on Equity, are also generally high across the Asset Management sector, with Polar Capital posting a very respectable 23% ROE (Figure 5):

5. US + UK Asset Managers' Return on Equity

Finally, net cash on balance sheets is high across UK asset managers, averaging over 14% across the sector ex Polar Capital, while Polar Capital itself has an even better 24.6% level of net cash on balance sheet as a percentage of current market capitalisation, better than any other major asset manager bar Man (LON:EMG) (Figure 6):

6. UK Asset Managers' Net Cash on Balance Sheet as % of Current Market Cap.

Basic Valuation Also Looks Attractive

Aside from the high dividend yield, bear in mind that the forecast P/E (once cash on balance sheet is substracted) comes out very cheaply at under 9x for March 2015 and an Enterprise Value/EBIT ratio of only 7.3x, while book value growth has been impressive since 2010 too. 

So What's The Catch? Slowing AUM Growth, Stock Market Risk

a. End-June: First Outflow in 15 Quarters 

The latest statement on assets under management as of 30 June revealed that AUM had only grown 3% in the quarter since the end of March, in effect suffering a net outflow for the first time in 15 quarters. This marks a pause in their impressive growth rate, which had seen AUM grow from just $2.5bn in March 2010 to $13.2bn by March of this year (Figure 7):

7. Polar Capital's Impressive AUM Growth Track Record

b. High Stock Market Beta: Great When Stocks Rise, But Painful in a Bear Market 

Clearly, while asset managers tend to see growth in AUM and thus rising profits in a bull market, they are also very sensitive to a bear market, when they tend to under-perform benchmark stock indices like the FTSE 100, as was the case back in 2008 and 2011, when both US asset managers (black line) and UK asset managers (yellow line) suffered greatly (Figure 8):

8. High Market Beta Means Pain During Bear Markets for Asset Managers

With all this in mind, I still find Polar Capital (LON:POLR) very tempting at the current share price of a tad under 430p, resulting in a single-digit ex-cash P/E valuation, particularly given that one is paid to wait by the generous dividend yield. 

Remember that with 32% of Polar's shares held by directors and employees, their interests are very much aligned with other shareholders!

But of course, Do Your Own Research as ever!

Edmund

- See more at: http://www.stockopedia.com/content/warm-up-on-polar-capital-86071/#sthash.uWUExNkc.dpuf

VIDEO: Why September is a Danger Month for Equities; but better for Bonds, NatGas, Gold...

Click below for a 3-minute Video Presentation on the Seasonal Dangers for Stocks,
and Why September is Better for Bonds, Gold, Gas

Beware September; A Danger Month for Equities!

1. September Has Been The S&P’s Worst Month

2. Mid-September to Early October is Worst

3. Healthcare Does Best

4. Long Bonds Are Still A Good Place to Be

5. As Is Gold

6. Gold Stocks Get a Leveraged Boost

7. Natural Gas Tends To Be A Big Sept-Oct Winner: +22% in 2 Months on Average!

8. Total A Good Natural Gas Play

Summary

1. Equity Markets Often Suffer in September
2. Long Bonds Tend To See Lower Yields
3. Sectors: Technology is Worst-Hit, Healthcare Does Best
4. Two Commodities to Like In Sept-Oct: Gold, Natural Gas
5. Two Stocks to Like: Goldcorp, Total

Sources for charts and tables: www.equityclock.com, www.stocktradersalmanac.com

Global Strategy Weekly in Charts: Stocks to return to recent highs, then what?

Macro: Better US Outlook, But Europe Worrying

1. Markit Manufacturing PMI Points to Stronger US Recovery

2. US Initial Jobless Claims Back to Cycle Lows

3. Why the Fed Can Stay on Hold Longer: High 12.2% Under-Employment Rate

4. German 10-year Bond Yield < 1% Higlights Deflation Risk: ECB to Help?

Stock Markets: Tech, Financials Hit New High, Europe Rebounds

5. US Technology, Financials Sectors Break Out to New Highs

6. German Stocks Lagged Word By Over 8%; Now Catch-Up Time

Commodities: Has Crude Oil Found A Bottom At Last?

7. Brent Crude Oil Finally Bouncing Off $102/barrel

8. Oil Services, Exploration/Production Start To Recover

9. Nearly the Season for the Energy Sector To Perform!

Risks: Watch For Mid-Term VIX to Return to <13

10. Mid-Term VIX Volatility Index Under 13 Will Flag Renewed Risk to Stocks

11. Warning: US Retail Sentiment Back to Bullish High (Contrarian Signal)

Investment Summary

1. US Economic Recovery Seems to be Improving
2. But High Under-Employment Means the Fed Can Wait…
3. Risk-On Recovery Driving US Tech Financials To New Highs
4. European Stocks Still Primed To Recover, But Hinges on the ECB
5. Opportunity to Return to Oil Stocks As Brent Crude Bottoms
6. Watch for the Mid-Term VIX to Dip Under 13; then risk/return may change

Edmund

Is India the First among Emerging Market Equals? Time to buy?

Astute observers will have noticed that the Indian Sensex index has just hit a multi-year high at over 22,000 (Figure 1).

1. THE INDIAN SENSEX INDEX HITS A NEW MULTI-YEAR HIGH

Source: Bloomberg

Not only that, but the Indian rupee has also started to gain ground against major currencies such as the US dollar, the euro, and sterling.

Given the relatively poor backdrop for most emerging markets thanks largely to Russia and China, why is India bucking the trend so successfully?

New central bank governor, maybe a new government?

A widely respected central bank governor, Raghuram Rajan, has already been installed at the Reserve Bank of India. He has lent a lot of credibility to the central bank policy of attempting to control Indian inflation which is still relatively high at 8.1%, but which is finally starting to come down.

A second driver for a positive view on India comes from Indian politics. Parliamentary elections are due to be held soon in India, and current opinion polls indicate that Narendra Modi’s Bharatiya Janata (BJP) opposition party is likely to win power, ousting the long-serving Congress party in the process. This is being seen as a good opportunity to see widespread reform within India, which may remove some of the structural roadblocks to Indian growth.

Clearly, while it is not clear that tensions over the Russian annexation of Crimea are calming or that sanctions will not be intensified on the part of the US and European Union, and while it is not clear as well that China will reignite growth in the near future, nevertheless India remains a bright spot within the emerging market universe.

Please click on the web link below to read the rest of the article and see the
ETFs and investment trusts recommended:  

  

Mindful Money: :Time to Buy India Today?

  

  
All the best, 
Edmund 

Footsie reaches for the 7000 mark. But there are better places for your money!

A lot has been made in recent days of the fact that the iconic FTSE-100 index (that has existed since 1986) is close to breaking its 14-year high, reached during the technology bubble back in early 2000.

Will the Footsie break through to a new multi-decade high? How much further can it go if it does? These questions are all well and good, but are not really the right questions to be asking.

In the Stock Market, Size is not Everything!

Should you even be looking at the benchmark FTSE-100 index at all? The real value creation in the UK stock market has not been in these largest of companies, dominated over time by Banks, Telecoms companies and Oil majors. Instead, investors have been far better served by the mid- and small-cap segments of the UK market, not only over the past 14 years but even further back as well.

Including reinvested dividends over time, the FTSE-100 has given investors a mere 3.7% on average since the end of 1999 (the line in black on the chart – and that’s not counting management fees even in an index fund); compare this to the 6.5% pre-fees from the Small-Cap index (in green) and an impressive 10.2% pre-fees from the Mid-250 index (in red), nearly three times the average return from large-caps!

This was largely achieved through two key biases:

1. A bias towards domestic economic exposure, which is greater in the mid- and small-cap segments of the stock market. In contrast, FTSE-100 companies tend to be global by nature, and indeed often have little to do with the UK per se (look at the Miners, for example).

2. Low weightings in hard-hit sectors, such as Banks, Insurance, Telecoms and Oil Majors. All of which have come a cropper either during the recent Financial Crisis, or before that post the 1999-2000 Tech bubble.

3. Let us not forget either that smaller companies generally also post higher growth rates in sales and profits too…

Despite this superior performance record for mid- and small-caps, you can’t even make the argument that mid- and small-cap companies are now systematically over-valued with respect to their large-cap counterparts: the estimated Price/Earnings ratio for the FTSE 100 is a little lower than for the Mid 250 index at 12.5x versus 14.6x, but it is not as low as for UK Small Caps, which trade at only 11x estimated end-2014 profit.

To see the charts, and look at the ETF and investment trust selections that I think will beat the FTSE-100 going forwards, please click on the Mindful Money web link below:

Footsie reaches for the 7000 mark. But there are better places for your money!

Until the next time,Edmund

Still time to climb on the housebuilders’ ladder

Surely UK house builders have done so well already, that they can’t possibly have much further to go? When the heated state of the UK housing market becomes headline news on a regular basis, then as a stock investor, you have to be worried, right?

While that might normally make sense, in this case I would beg to differ. It is true that, since I wrote my last article extolling the virtues of UK house builders on February 4 (UK Building is All Systems Go!), the Bloomberg UK house builders’ index has risen some 9%, its pullback today notwithstanding.

But let me present a series of data that I find to be compelling evidence that the current bull market in housing-related stocks  still has some way to run…

Item 1: House Builders have 37% to go to Reach their 2007 Highs

Yes it is true! As a group, house builders like Barratt Developments (BDEV), Berkeley Group (BKG) and Persimmon (PSN) have 37% further to rise before they hit their June 2007 share price highs.

Item 2: Housing Starts Are Picking Up, But Still Below Average 

House builders are breaking ground on more new projects today than at any time since the first quarter of 2008. However they are still a long way from climbing back to the average for quarterly housing starts seen pre-Financial Crisis. 

Item 3: and Building Completions Are Even Worse…

If we look at the rate of building completions in the UK, the situation looks even worse...

Item 4: Mortgage Approvals Go Up, Mortgage Rates Down

And all the while, the UK Government is of course doing its bit to help the purchasing of new-build homes with their Help to Buy schemes, effectively guaranteeing the first 20% of a 95% loan-to-value mortgage, allowing first-time buyers to get on the property ladder with only a 5% deposit. No wonder then that the number of mortgage approvals is going up!

To read on, see the charts and see my favoured stocks for this theme,
click on this web link: 

Still time-to climb on the housebuilders' ladder

Video Slideshow: Bull or Bear Market? Which sectors to favour?

Hello again,

 

I offer you this time a 5-minute video slideshow with audio commentary, tackling two questions:

 

1. Are we still in a Bull stock market or have we entered a Bear market?
2. Which industry sectors should you favour?

 

 

All the best,

Edmund

Explore oil services for attractive value and momentum

Oil services coming back into vogue

As a contrarian value investor by nature, I like to look at sectors that have under-performed and which look to offer long-term value. If we look at the performance of the various S&P 500 sectors since the beginning of this year, the Oil & Gas sector stands out as one of the worst performers, with the iShares US Energy ETF falling from $50.50 at end-December 2013 to $46.40 by the beginning of February.

Since then, however, the Oil & Gas sector has staged somewhat of a recovery – still, over the last three months, the iShares Oil Equipment & Services ETF has lagged the S&P 500 by 4% (Figure 1).

However, in the long-term, I still see the Oil Equipment & Services sub sector remains an excellent way to take a “picks and shovels” approach to investing in the US shale oil & gas theme. The crude oil price has, if anything, moved higher over this period, judging by the Brent Crude Oil ETF (BNO; Figure 2).

To read the rest of this article and see my 3 favoured European stock picks to ride this Oil Services recovery, please click on the Mindful Money article link below:

Explore Oil Services for Attractive Value and Momentum

All the best for the week ahead,
Edmund

Weekly Newsletter: February 17, 2014 - Focus on SmallCaps

Weekly Spotlight on: Small-Cap Stocks

While global stock markets have continued their steady recovery following January’s emerging market-led swoon, a difference in performance is emerging between small-cap stocks Stateside and those both located in the UK and also in Europe. 

Now normally, you could expect the performance of small-cap stocks in general to be driven broadly by two factors: 

 Firstly, the direction of the broader stock market, as small-cap stocks tend to have a beta higher than 1 as a group; that is to say, when the benchmark stock market indices are moving higher, small-caps tend to move higher even faster. Conversely, when stock markets are correcting, small-caps tend to suffer more as small-cap liquidity can dry up, causing wider swings in stock prices on lower volumes.

 Secondly, small-caps tend to be driven more by the momentum in the domestic economy than large-caps given their greater domestic exposure. So when the domestic economy is improving rapidly, as it is currently in the UK, you would expect small-caps to be more responsive to this trend and outperform their large-cap compatriots.

Now small-caps are indeed outperforming the large-cap stock indices in the UK and Continental Europe as you would expect given rising stock markets and positive signs from the UK and Eurozone economies. 

UK SmallCap ETF BEats the Footsie Hands Down

Source: Yahoo Finance

However, this is no longer the case in the US, after an impressive 2013 when US stocks did well (the S&P 500 benchmark index gained over 30%) and small-cap stocks did best of all (+37% over calendar 2013!). 

Why might this be? Well, there are some signs that the US domestic economy is not perhaps growing as robustly as was previously thought. Employment growth (as measured by the non-farm payrolls data) has been much weaker over the past two months. 

Now while some of this weakness may be attributable to the extremely cold weather hitting much of the US over this period, there are also lingering suspicions that better US economic growth is not translating into better job growth, suggesting that the peak in domestic US growth may already be behind us. Hence the relative weakness in US small-caps, reflecting these economic doubts. 

A second factor to bear in mind is valuation: US small-caps now sit on average at a hefty valuation premium to large-caps, when traditionally small-caps have traded more often at a discount to the largest US companies. This suggests that for US small-caps to grow into their higher valuations, they are going to have to convince investors by posting superior earnings growth from here on out. 

In the meantime, I think I shall be calling time on my US small-caps ETF strategy, and instead looking at different investment styles for my ETF exposure to American companies. As the eagle-eyed may have spotted in lat week’s weekly newsletter, my favourite ETF/investment trust portfolio includes a Nasdaq 100 ETF (EQQQ.L), rather than any US small-cap ETF, as I am still very partial to US technology exposure. 

But what about UK, Euro Small-Caps?

In contrast, I am still keen on exposure to UK and Euro small-cap ETFs and investment trusts, as the situation here is somewhat different. 

Euro SmallCap ETF Heading Back To Highs

Source: Yahoo Finance

Firstly, the valuation differential between small-cap and large-cap indices is not at all extreme on this side of the Atlantic; if anything, small-caps still trade at a modest valuation discount to large-caps.

Secondly, the economic evidence is different in that the UK and Eurozone are still seeing improving domestic trends. The UK case is relatively clear-cut, with employment growth still accelerating rather than slowing down (albeit disproportionately driven by the “London effect”). 

In the Eurozone, economic growth rates are still modest but are improving, with Friday’s Q4 2013 GDP growth data beating analysts’ expectations. The employment data in the Eurozone is very variable, but we can start to discern slow improvements even in peripheral countries such as Spain and Ireland. 

So for these two reasons, I shall be maintaining my UK and Euro small-cap fund selections in the Model ETF/IT portfolio.

The Idle Investor’s Model ETF & IT Portfolio

The table below details the 6 UK-listed ETFs and investment trusts (3 of each) that I favour at the moment. There are a number of other ETFs and closed-end funds that I am keen on in the US, but have not included here for reasons of simplicity.

Company	Code	Share Price Feb. 7, 2014	Share Price Feb. 14, 2014
iShares MSCI UK Small-Cap ETF	CUKS.L	15,027p	15,276p
Source GLG/Man Europe Plus ETF	MPFE.L	10,999p	11,126p
iShares Japan GBP-Hedged ETF	IJPH.L	4151p	4136p
Inveco Perpetual Enhanced Income IT	IPE.L	73.0p	72.0p
Fidelity Asian Values IT	FAS.L	198p	202.5p
Herald IT	HRI.L	715p	726.5p

Well four out of the six funds saw gains over the week, with the UK Small Caps leading the way in the form of the Small Cap ETF and also the Herald investment trust. 

In contrast, the Japan ETF struggled this week as the Japanese yen strengthened, with continued doubts over the success of Prime Minister Abe’s “Abenomics” economic revival plan. I remain convinced that China should see better days ahead, and that this should have positive knock-on effects for the Japanese economy and stock market, which on certain profit-based valuation measures looks cheaper than it has for many, many years. 

This Week’s Articles, In Case You Missed Them…

I wrote a couple of articles on Gold and on Europe in my Mindful Money Expert Opinion column this week:

1. Focus on Gold Miners as gold glitters once again: Gold bugs have had a good start to 2o14, unlike those invested in stock markets. While the FTSE 100 index has lost 1% over the year to date, in contrast gold futures have gained over 7% in US dollar terms. Billionaire hedge fund manager John Paulson’s Gold Fund gained some 18% over the month of January, according to Institutional Investor Alpha. What are the best ways to play the gold rally? Click on the article to find out…

2. Buy Europe! The ECB will have to give the Euro economy a boost: Yes, I know that you may be hesitant to buy Continental European stock market exposure, given the travails of the Euro zone since 2008. And you would be right to object that the Euro zone sovereign crisis has by no means been definitively solved, with debt loads of countries such as Portugal, Spain and Italy still pretty enormous.

I am a firm believer that the European Central Bank (the ECB for short) will need to stimulate the Euro zone further in the months ahead, which should be unabashed good news for the European stock market.

There is also a video interview you can watch:

3. Bloomberg TV interview: Focusing on Euro corporate results. 

I invite you to cast your eyes over my Bloomberg TV appearance early (too early, at 6:10am!) this morning, commenting on corporate results from: Rio Tinto, BNP-Paribas, Commerzbank and Nestlé.

Have a great week ahead, and please don’t hesitate to recommend this newsletter to anyone who you know may be interested: to subscribe, please just email me at 

    idleinvestor@idleinvestor.com

The best of luck for the week ahead,

Edmund