ARE SMALL CAPS MAKING A COMEBACK (ASL)

Article in the investors Chronicle 27.3.09 page 48 -Algy Hall:-
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Up until the start of this year, one of the abiding rules of the bear market was "big is beautiful". Indeed, in every quarter since the market peaked in mid-2007 the blue-chip FTSE 100 index has outperformed both the FTSE Small Cap and FTSE Fledgling indices, and during most quarters the outperformance has been extreme. But this trend has gone into reverse so far in 2009 - and that offers some grounds for hope that we may be approaching the bottom.Heading for the exit
When markets fall there are good reasons for the flight from small caps. After all, their size makes them more vulnerable to the type of trading difficulties that all businesses face during a recession, such as cancelled orders and unhelpful bank managers. Small caps also tend to have a domestic focus which makes them very sensitive to problems in the UK economy, and they have not benefited from recent currency movements in the same way as the big-dollar-earning blue chips. Small-cap shares tend to be very illiquid, which makes prices more sensitive to any distressed selling. And they are riskier, and so are sold off whenever risk aversion rises.
That's why, since the market began to head south, the FTSE 100’s 42 per cent loss has been considerably more palatable than the FTSE Small Cap’s 58 per cent fall, the FTSE Fledgling’s 55 per cent plunge and the FTSE AIM All Share’s 67 per cent decline.
All change
However, for a first time in this bear market, it looks like smaller companies are set to outperform blue chips over a quarter-year period. With the first three months of 2009 almost complete, the FTSE 100 has dropped 11.9 per cent while the FTSE Small Cap is down 7.1 per cent and the FTSE Fledgling is actually up 11.9 per cent. Long-suffering Aim is also in positive territory, having clawed a 1.4 per cent gain.
The positive momentum in smaller company shares could prove to be an important distinguishing feature in the market's latest rally compared with the many other bear market bounces we’ve experienced. That’s because small caps are usually at the forefront of genuine market recoveries. The habit of small caps to outperform during a recovery is partly due their sensitivity to changes in economic conditions, which means they outperform in anticipation of better times to come. The other key factor, and perhaps the most relevant at the moment, is that small caps tend to be heavily oversold in the rush for the exit during a bear market, which creates some excellent value opportunities once the dust settles. So the recent fillip could be a sign that even if the recent rally proves to be just another false dawn, the market is at long last finding valuations with which it is comfortable.
A bright future
Fund manager Gervais Williams, who runs the Gartmore Growth Opportunties and Gartmore Fledgling investment trusts, believes that there could be something even more profound at work than a simple recognition that small caps are – as he puts it – “embarrassingly cheap”. Mr William says, “I think there will be a big trend away from large caps to small caps over the next five years or so… driven by dividend distribution.”
Mr Williams argues that large caps are over geared after many years of paying excessive dividends and will have to make unprecedented cuts – he points to the futures market which suggests cuts in the region of 50 to 60 per cent. Meanwhile, profitable small caps with decent balance sheets are in a position to reduce their focus on reinvesting profits for growth and to start paying out more in dividends. This would make them one of the only options for those seeking large and growing yields.
Such a shift in sentiment towards small caps would be radical given the long-term movement in the other direction. Over the last 20 years the FTSE Small Cap index has actually fallen 1.2 per cent compared with an 88.1 per cent rise from the FTSE 100. But whether or not such a seismic shift
occurs, the recent outperformance by small caps is a reason for encouragement.
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If you look at one of the best Investment Trust look at the chart for 2009.
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