Research by this team of City analysts shows that small-cap stocks typically outperform the FTSE 100 by miles during a certain point in the cycle. Here are the dates they expect it to happen this time.
Analysis of recessions going back to 1986 has highlighted how mid- and small-cap stocks are more likely to outperform FTSE 100-listed companies towards the end of a downturn.
The chart published by strategists at Liberum shows blue-chips up by 3% in the period covering the last two quarters of a recession and the first two quarters after a recession. That compares with increases of 11.2% for the FTSE 250 index and 14.1% for the FTSE Small-Cap.
The findings reinforce the City broker’s expectations for similar market behaviour between the second quarter of 2023 until the equivalent three-month period in 2024.
It said earnings are just one part of the reason for the outperformance by small- and mid-cap (SMID) stocks, with a bigger factor being moves in discount rates (long-term bond yields).
Liberum explained: “Share price reactions are some 10 times more sensitive to changes in discount rates than to changes in earnings. Thus, especially towards the end of a recession, SMID stocks typically outperform large caps as bond yields decline.”
The FTSE 100 index recently touched a record high and the FTSE 250 traded above 20,000, having been as low as 16,661 in the autumn.
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However, Liberum points out that its investor sentiment indicator shows that the UK market has gone above what can be justified by fundamentals.
It added: “While pessimistic investors and consumers might support a rally for a little bit longer as they become more optimistic, fundamentals have to improve or the market rally will falter.”
Liberum believes the UK market entered another overbought position in mid-January, indicating “that we need to work off recent advances in the coming months”.
It said: “We have not seen a volatility spike in the US or Europe, indicating that investors remain relatively complacent about the coming recession even though earnings are now downgraded rapidly.”
There are nine blue-chip stocks on the 20-strong list published on Friday, including NatWest Group (LSE:NWG), Lloyds Banking Group (LSE:LLOY), International Consolidated Airlines Group SA (LSE:IAG), Burberry Group (LSE:BRBY) and Smiths Group (LSE:SMIN).
The most oversold stock is Spirent Communications (LSE:SPT) after reporting that its performance is now likely to have a heavier than usual second-half weighting as customers take longer to reach investment decisions.
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The largest upgrades to earnings guidance across a two-year horizon have been for IAG and Whitbread (LSE:WTB), with the biggest downgrades for the builders Persimmon (LSE:PSN) and Taylor Wimpey (LSE:TW.)
Since 2000, Liberum notes that buying the highest-yielding stocks each month has generated significant outperformance over the lowest-yielding stocks.
However, it finds that January was a month for stocks with low dividends or no dividends after they outperformed income stocks by 2.1%.
Last month’s cheapest FTSE 350 stocks by forward dividend yields across a two-year horizon are Energean (LSE:ENOG) at 8.6% and Glencore (LSE:GLEN) at 8.3%, followed by the traditional income stocks British American Tobacco, Aviva (LSE:AV.), Legal & General (LSE:LGEN)and Imperial Brands (LSE:IMB) near to 8%.
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