In the months ahead, macroeconomic volatility is unlikely to abate. Even if the interest rate and inflation environment is stabilising, a slew of elections – particularly the General Election in the UK and the Presidential election in the US – are likely to inject turbulence. However, there are reasons for optimism among smaller company investors, with a tentative improvement in economic conditions and sentiment.
Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.
It has been a tough period for investors in UK smaller companies, which have been seen as more vulnerable to rate rises and to weakness in the domestic economy. This isn’t necessarily the case, but this nuance has been lost in an environment where fundamentals have often been overlooked in favour of a narrow focus on the direction of central bank policy.
As such, the improving economy is likely to be a tailwind for sentiment, even though many of the companies in our portfolio were already doing well operationally. While the UK’s flirtation with recession was unwelcome, there are already signs of an improvement in economic conditions. Inflation and mortgage rates are falling, while productivity, factory construction and corporate profits are rising. Labour markets are showing signs of softness but remain robust, with some real wage growth for the first time in years.
Inflation outlook
Inflation could tip below the Bank of England’s target within months. Much of the inflation pressure of last year is becoming deflationary: oil and gas prices are low, which will continue to alleviate pressure on corporate input costs and consumer wallets, as will recent food price cuts announced by the supermarkets. The change in the energy price cap is also likely to help household finances.
The Bank of England has made it clear that it is willing to start cutting rates before hitting the 2% target1. Governor Andrew Bailey said market expectations that there would be rate cuts this year were not “unreasonable”, but he would not be drawn on extent or timing of cuts. There has been a correlation between interest rate expectations and small and mid cap performance.
It is noteworthy – and encouraging - that small and mid caps have rallied versus their large cap peers as interest rate expectations have dropped since November2. We believe this shift is likely to bring about a broadening out of market leadership away from some very narrow areas of outperformance, both in the US and the UK, which should be a net positive overall for investing in smaller companies.
On the BlackRock Throgmorton Trust, we do not believe the economy has to be particularly strong, or that interest rates have to be cut particularly hard for smaller companies to do better. Many of the companies in our portfolio are relatively insensitive to the domestic economy, operating in fast-growing niche areas. However, any improvement will help sentiment towards this unloved part of the UK market.
The recovery is not reflected in the valuations of UK small and medium sized companies, we believe, which continue to anticipate a far darker outcome for the UK economy than is likely. In the meantime, investors in smaller companies are getting ‘growth’ stocks at ‘value’ prices.
Sources:
1 Financial Times - Bank of England may begin cutting rates before hitting 2% inflation target – 20th February 2024
2 FTSE Russell – FTSE 100 Factsheet – 31 January 2024
Risk warnings
Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy.
Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.
Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy.
Investors should refer to the prospectus or offering documentation for the funds full list of risks.
Description of Fund Risks
Complex Derivative Strategies: Derivatives may be used substantially for complex investment strategies. These include the creation of short positions where the Investment Manager artificially sells an investment it does not physically own.
Derivatives can also be used to generate exposure to investments greater than the net asset value of the fund / investment trust. Investment Managers refer to this practice as obtaining market leverage or gearing. As a result, a small positive or negative movement in stock markets will have a larger impact on the value of these derivatives than owning the physical investments. The use of derivatives in this manner may have the effect of increasing the overall risk profile of the Funds.
Counterparty Risk: The insolvency of any institutions providing services such as safekeeping of assets or acting as counterparty to derivatives or other instruments, may expose the Fund to financial loss.
Financial Markets, Counterparties and Service Providers: The insolvency of any institutions providing services such as safekeeping of assets or acting as counterparty to derivatives or other instruments, may expose the Fund to financial loss.
Gearing Risk: Investment strategies, such as borrowing, used by the Trust can result in even larger losses suffered when the value of the underlying investments fall.
Liquidity Risk: The Fund's investments may have low liquidity which often causes the value of these investments to be less predictable. In extreme cases, the Fund may not be able to realise the investment at the latest market price or at a price considered fair.
