The Great British Sell-Off – does it provide an opportunity for micro-caps?

Gervais Williams and Martin Turner, managers of the Miton UK MicroCap Trust, look at the reasons behind the Great British Sell-Off and whether it provides an opportunity for micro-companies.

For information purposes only. Any views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.

Investing involves risk. The value of an investment can go down as well as up which means that you could get back less than you originally invested when you come to sell your investment. The value of your investment might not keep up with any rise in the cost of living.

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The effect of the US giants 

Whilst the rise in global stock markets became quite widespread in the final part of 2023, in the early part of 2024, US mega companies’ outperformance has become the dominant theme again. US Gross Domestic Product (GDP) accelerated in the final quarter as a result of extra spending under the terms of the Inflation Reduction Act – legislation designed to encourage investment in green energy – funded by an increase in US government borrowing. The net effect was that US company results typically outpaced expectations, with Nvidia’s share price in particular rising dramatically.

US stock market outperformance continues to weigh on the valuation of the UK stock market. During the globalisation decades, the low-beta nature of the UK market has led to its return and its valuation lagging other markets. (Beta is a measure of how the price of a particular investment or group of investments moves in relation to the wider stock market). Overseas investors withdrew capital, so they could participate in superior returns elsewhere. As the returns on the seven large US mega-companies – the so-called “Magnificent Seven” – have accelerated upwards over recent years, UK investors have also reduced their holdings in UK funds, which the chart below highlights.

Annual investment into UK Equity Funds

Source: Numis research

 

What has this meant for UK companies, particularly micro-companies?

This adverse trend has weighed most heavily on UK small and micro-companies listed on the UK stock exchange (UK stocks). Whilst UK investor selling of UK stocks may have accelerated, many large companies have been able to generate surplus cash (cash that exceeds the required for day-to-day operations), some of which they have been able to deploy to buy back their own shares, counterbalancing this selling pressure. As a result, the return from the FTSE 100 Index has largely kept pace with other global stock markets. UK small and micro-companies are more likely to be focused on investing for the future, so do not have the same levels of surplus cash available to buy back their shares. 

What do we expect from here?

The current global economic outlook is mixed. Whilst elevated interest rates have dampened global demand, in the US this has been offset by measures to encourage growth. In the first half of 2023, actions by the Federal Reserve Bank to help address the growing issue of near-insolvency amongst a number of regional banks were followed by the implementation of the Inflation Reduction Act.  As the effects of this started to take hold in the US in late 2023, higher interest rates without extra stimulus led to weakening economies in Europe and Asia.

Headwinds for 2024

While many stock markets may have risen over 2023, the headwinds for 2024 look more challenging. There is little economic momentum in Europe or Asia, suggesting that even with major interest rate cuts, these economies appear set to weaken further in the near term, as the effects of cuts will take time to feed through to the wider economy. Meanwhile, a higher level of US government borrowing may help boost that economy, but it comes with additional bond issuance that may absorb investors’ cash.

Given current US economic growth, US mega-company share prices have started 2024 well. But the longer that global interest rates remain elevated, the greater the dampening impact this will have on general levels of demand. When demand falls below supply, customers have pricing power and company profit margins become vulnerable. This has already been seen with the prices of electronic goods and cars coming under downward pressure. In time, we can expect a similar trend in the service sectors, which importantly comprise a much larger part of the global economy.

A particular opportunity for micro-caps… 

This will be a challenge for all businesses, both large and small, but larger companies are potentially more vulnerable. When demand weakens, large companies can struggle to pick up additional sales elsewhere, at a rate fast enough to offset that declining demand. In contrast, whilst some micro-companies may suffer, their immaturity means that those with resilient business models have a greater chance of keeping their businesses moving forward.

If the global downturn were to be more severe than expected, then listed micro-companies with relatively strong balance sheets and the potential to raise additional funding might have an even greater chance of bucking the trend, by investing in their businesses at a time when others are constrained. This can generate greater returns which may be transformational to listed micro-companies earnings and share prices.

…as UK prospects start to improve 

Meanwhile, the prospects for UK investors may in fact be improving. January’s inflation rate fell to 4% from a peak 12 months earlier of over 10% and is forecast to fall further over the next few months. As a result, UK interest rates, together with those of other European economies may be set to come down before those of the US. Such cuts, together with the Chancellor’s recent budget announcement regarding a ringfenced UK ISA, have the potential to reduce withdrawals from UK funds and could even bring in some new capital from overseas investors, if they start to recognise that the UK stock market, and UK small/micro-companies in particular, are standing on such low valuations.

We therefore believe that the potential of the UK stock market is much greater than appreciated, and that the best performing part of it could be UK-listed micro-companies. In time, even professional small company investors who have little micro-company exposure may find they need to participate, or else risk underperforming. Hence, we anticipate that UK micro-companies, when their recovery finally comes, might grow a lot faster than expected for a decade or more.

 

Gervais Williams & Martin Turner

Fund Managers, Miton UK MicroCap Trust

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Risks

Typically, there is less risk of losing money over the long-term (which we define as over 5 years) from an investment that is considered low risk, although potential returns may also be lower. Investments considered higher risk typically offer greater opportunities for better long-term returns, though the risk of losing money is also likely to be higher.

Forecasts are not reliable indicators of future returns.

Glossary

Bonds (or fixed income)

Types of investments that allow investors to loan money to governments and companies, usually in return for a regular fixed level of interest until the bond’s maturity date, plus the return of the original value of the bond at the maturity date. The price of bonds will vary, and the investment terms of bonds will also vary.

Capital

Describes financial assets, particularly cash, or other assets, such as shares, owned by a person or organisation.

Equities

Another name for shares (or stock) in a company.

Market capitalisation

The total value of the shares of a company, often referred to as ‘market cap’. For example, large companies are referred to as ‘large cap’, medium sized companies as ‘mid-cap’ and small companies a as ‘small cap’.

Share price

The amount it would cost to buy one share in a company; it is not fixed but fluctuates for many reasons, including the success of the company and market conditions.

IMPORTANT INFORMATION:

IMPORTANT INFORMATION:

Whilst every effort has been made to ensure the accuracy of the information provided, we regret that we cannot accept responsibility for any omissions or errors.

The views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.

Reference to any particular investment does not constitute a recommendation to buy or sell the investment.

All data is sourced to Premier Miton unless otherwise stated.

Issued by Premier Portfolio Managers Limited, (registered in England no. 01235867), authorised and regulated by the Financial Conduct Authority, a member of the Premier Miton Investors marketing group and a subsidiary of Premier Miton Group plc (registered in England no. 06306664). Registered office: Eastgate Court, High Street, Guildford, Surrey GU1 3DE.

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Premier Miton Investors has expressed its own views and opinions on this website, and these may change and there is no obligation to update them. Nothing in this website should be construed as investment, tax, legal or other advice. The information contained herein is subject to change without notice.

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By clicking accept you acknowledge that your use of this website is subject to our privacy policy, cookie policy and our general legal and compliance information available on our website.

THE UNITED STATES OF AMERICA: The investment products referred to on this website have not been and will not be registered under the United States Securities Act of 1933, as amended. They may not be offered or sold in the United States of America, its territories and possessions, any State of the United States of America or the District of Columbia or offered, sold or transferred to US Persons (as defined below). The investment products referred to on this website have not been and will not be registered under the United States Investment Company Act of 1940, as amended. Premier Portfolio Managers Limited has not been and will not be registered under the United States Investment Advisers Act of 1940.

 “US Person” generally includes the following: (a) any natural person resident in the United States; (b) a partnership or corporation organised or incorporated under the laws of the United States; (c) any estate of which any executor, or administrator, is a US Person; (d) any trust of which any trustee is a US Person; (e) any agency or branch of a non-US entity located in the United States; (f) any non-discretionary account or similar account (other than an estate or trust) for the benefit or account of a US Person; (g) any discretionary account or similar account (other than an estate or trust) held by a dealer or other fiduciary organised, incorporated or (if an individual) resident in the United States; and (h) any partnership or corporation if: i. organised or incorporated under the laws of any non-US jurisdiction; ii. formed by a US Person principally for the purpose of investing in securities not registered under the 1933 Act. In addition, a Shareholder must qualify as a “Non-United States Person” as used in the US Commodity Futures Trading Commission (“CFTC”) Rule 4.7.

 Investment products referred to on this website may not be sold or transferred to a US citizen, or an entity taxed as such or required to file a tax return as such under the United States federal income tax laws (a “US Tax Resident”). If those investment products are held by a US Person, a US Tax Resident or a person who does not qualify as a “Non-United States Person” within the meaning of CFTC Rule 4.7, Premier Portfolio Managers Limited shall be entitled to redeem such Shareholder’s entire holdings.