Market Wrap: Small-cap pain (Friday 13 May, 2022)

Welcome to this week’s Market Wrap. A quick glance at the 1-month performance figures for some of the main western indices tells you all you need to know about general sentiment in recent weeks. The large-cap US Samp;P 500 is down 10% over the past month – with spiralling inflation being a key factor in all the unease. More on that shortly.

Index changes

Source: Stockopedia, London Stock Exchange

Factors and markets

For individual investors, of course, small-cap performances are equally (if not more) meaningful than what the large-caps are doing. Alas, on this front the performance year-to-date has been dire. Small-cap indices across these territories are well underwater, with US and European indices in minus mid-teen territory.

The UK’s AIM All Share is down by nearly 20% year to date (22% over a year) – making it a particularly difficult place to be for investors.

Out of 842 companies on AIM in April:

• 25 were valued at more than £1 billion
• 236 were valued at between £100m and £1 billion
• 581 were valued at up to £100 million (of those, 323 were valued at less than £25 million)

As you can see, AIM is dominated by large numbers of companies with relatively small market caps (and many of those capitalisations have got a lot smaller in 2022). In good times, of course, these stocks can rerate strongly. But in down markets, they get clattered.

For the optimists, it could be here that some stocks have sold off too far. If inflation levels start to ease, some of the higher quality names (which haven’t been immune from the downward trend) could end up looking like bargains. But that’s very much territory for the brave – and things could get worse before that.

What has happened with AIM this year has really been an acceleration of a trend over many months towards investors becoming risk-off, with preferences shifting from Growth to Value. In the UK market that’s manifested itself in a strong move away from smaller, more speculative growth plays, exacerbated by rising inflation, which makes pre-profit companies harder to value.

Instead, attention has turned to more defensive large-caps elsewhere. This is partly why the FTSE 100 is still in positive territory. Those traditional stalwarts in energy, finance and consumer defensives, many of which are relatively cheap, are propping things up.

But while we’re seeing evidence of this Growth/Value shift in the UK market, it’s even clearer in the US. According to Samp;P Indexology, in the first quarter of 2022, Value (-5.0%) outperformed Growth (-20%) with a differential that’s startling by historical standards. As they point out, as recently as last autumn the gap actually favoured Growth by 10%.

This chart compares January-April 2022 to all other rolling 4-month intervals in the Samp;P database – it shows just how sharp the swing has been.

One of the problems with this Growth/Value discussion is that it can be a little bit abstract. It hints at the way investors are feeling, and perhaps positioning themselves, but it doesn’t really give away much else. Quite a fun view that offers a little more detail, was an update this week from the broker, Liberum.

Their analysts track trends in Google search to try and understand what’s on the minds of investors. Looking at their most recent findings, it’s clear that exotic investments, tech, growth, metaverse and fintech have seen the strongest falls in interest lately.

In their place, smart beta and subjects around macroeconomics are in vogue. You can feel the cooling sentiment leaping off these charts…

Final thought…

Talking of abstract issues, inflation has been burning away as a potential investment risk for many months now. At the individual stock level, there are some cases where it seems clear how and why a company might be impacted by sustained high inflation. But in many other cases it’s not. Indeed, it’s not even clear whether inflation will stick around for long (it may do) or whether central bank policy (too little too late?) might influence it. Equally, is an inflation-induced recession really inevitable?

The finance professor and writer Aswath Damodaran is excellent on this stuff, and this blog he wrote about inflation recently is worth a read if you want to know about some of the moving parts.

Have a great weekend!

Stockopedia