PORTFOLIO Stocks & equity markets

The rally of small and midcap stocks

GAM is very optimistic on the prospects of small and midcap stocks for 2017.

Over the past five years, annualised returns in the sector have been close to 18%, as measured by the MSCI Europe Small Cap ND index (31/12/2011 to 31/12/2016). This year has started well and we do not see any reason why the asset class cannot continue to post similar returns. The fundamentals to support such returns are in place: earnings revisions are positive, driven by top-line growth (which we have not seen for some time). Consensus expectations are therefore around 8% for turnover growth and 19% for earnings-per-share growth. We view the latter as somewhat optimistic and believe that 14–16% is a more reasonable assumption.

The macroeconomic backdrop is also positive, in particular consumer confidence. Arguably, unemployment in certain parts of Europe remains elevated, but the prospects as well as the picture across the continent as a whole are sound. GDP growth is picking up and leading indicators are underscoring the recovery. The sentiment that we hear from the market and our companies, such as the construction sector, is also upbeat. The upturn in emerging markets, as well as continued strength from the US, should provide positive spill-over effects into our asset class.

There are political concerns regarding upcoming elections in Europe that are making investors wary. Our expectation is that elections in France should see a nonpopulist government win, which would pave the way for investors to flock back into European stock markets. Valuations in our space look attractive, we are only cautious on the micro-cap area. There, returns were stellar last year and we see complacency among investors as valuations are starting to look stretched.

For our portfolio, we look for companies with strong balance sheets, which are plentiful in the small and midcap space. With this solid financial underpinning, they are able to make the necessary investments to stay competitive or to enter new areas of future growth potential. Additionally, they often feature high dividend yields. Interestingly, the solid balance sheets also mean that our holdings are often active in mergers & acquisitions – more often than not as the acquirer. Looking at the portfolio composition, we tend to have a cyclical bias owing to the very nature of how the asset class is comprised. We are overweight in industrials, technology and consumer stocks. We prefer asset-light business models, as well as structural and cyclical growth names. Special situations also fit well into our approach, since bottom-up stock-picking can make a tangible difference here.

Guido Marveggio - GAM