The markets tell us what investors are doing. But what, exactly, are they thinking? Towards the end of every month, Edison takes you: Inside the Mind of Investors.
Despite the UK’s top 100 stocks hitting highs, the mood of investors remains somewhat undecided – caught between a bad and a better place.
Indices are up yet shocks continue, with geopolitical events creating more tension and interest rates deflating slower than expected. This combination has some fund managers crouching under their desks.
The highs are partially explained by investors’ white knuckles, grasping onto large and liquid assets ever so tightly. At the same time, macroeconomic indicators are tending to soothe those same nerves and open investors’ minds.
The effect is a price pop as higher levels of optimism increase demand for large stocks, leading to defensive holdings remaining firmly unsold.
While the market may be busy voting against other strategies, individual investors continue practicing zen and the art of equity investment.
Those committed to small- and mid-cap companies are focusing their mental energies on the business cycle. As tighter fiscal and monetary policies begin to bite, these investors remain convinced – despite some signs to the contrary – that interest rates will loosen significantly within the next six months. With cheaper debt and company earnings going up, these investors expect price momentum to take hold and the discount on small- and mid-cap companies to be eaten into, maybe even eliminated.
After all, capital always seeks a return. As UBS recently opined to Bloomberg, the improving economy makes the more ‘domestically exposed’ mid-cap companies in the UK look especially attractive.
In contrast, investors holding large- and mega-cap stocks are focused on structural issues. They point out that the average floor at which institutions can invest has been significantly raised, acting as a bar against small-cap demand under all conditions.
Not only do fewer large funds now have mandates to buy equities with a market cap of £250m or less, but there is also a trend of less capital committed to market-making and of hedge funds being urged to hold more liquid assets.
The floating investor is acutely aware of benefits and risks of both positions.
UK retail sales stagnated during March. This might support the rate cut and small-cap recovery hypothesis but total sales volumes have declined for three years. Will the UK consumer sector be able to bounce back?
Meanwhile, questions are being raised about the US. The Federal Reserve’s money creation during the pandemic (as well as the extra $18tn of government spending afterwards) may be similar to overdosing on sugar; it is continuing to fuel the nation’s highs but may inevitably lead to a sugar crash when supply dries up. What happens then?
Across the pond, the European Union is looking to stimulate small- and mid-cap markets with a new drive towards a single market for savings and investments. Given the impact of the single market on other goods and services, this may, over the long term, significantly help to rebalance demand for equities of all sizes. But will it deliver?
Given the complexity and continuing uncertainty of the landscape, it is no wonder many investors are caught between a bad place and one that looks significantly better.
The Edison View
The cycles in capitalism are, as ever, baked into the system and Edison believes small- and mid-cap stocks are currently in the eye of the storm. A recovery is inevitable, especially for those with tempting equity stories and IR teams actively positioning their message.
Although the trend towards favouring larger equities is likely to continue, there is a clear opportunity for businesses with market caps of less than £500m to use the recovery as a slingshot. The key is to impress the market with both their equity story and their results to push into the institutional sweet spot.
The objectives may have changed but this should give clearer focus to the strategies and tactics to be deployed.
Further reading:
Hedge funds urged to hold more liquid assets:
https://www.ft.com/content/d4517163-85ad-4af4-bd4d-2e26a44b49db
Visualising the trend towards bigger businesses:
https://www.visualcapitalist.com/americas-top-companies-by-revenue-1994-vs-2023/
Is the US economy overstimulated?
https://www.ft.com/content/f9d247d8-dfd9-4983-bf19-bc5837aa04ef
Small stocks, big problems:
https://www.ft.com/content/abfbf19e-f963-4c1b-b69e-7bef8896e8cd
UK consumer demand unchanged in March:
https://www.ons.gov.uk/releases/retailsalesgreatbritainmarch2024
Retail volumes shrink for three years running:
https://www.ft.com/content/6b9ab7e1-b9ad-4467-a97c-5a179be149b7
Empowering the Single Market to deliver a sustainable future:
https://www.consilium.europa.eu/media/ny3j24sm/much-more-than-a-market-report-by-enrico-letta.pdf
