Beer, gambling and Mad Men lead stocks boom

September 27, 2013 3:25 pm

Beer, gambling and Mad Men lead stocks boom

By FT Reporters

When it comes to big stock market gains, investors should look to beer, gambling, the macho culture of Mad Men and box office hits such as The Hunger Games. While many have opted for safety as equities have rallied in the wake of the financial crisis – favouring big, reliable dividend-payers – an eclectic group of global small-caps are setting a blistering pace. The MSCI World Small Caps index has climbed almost 22 per cent already this year, touching a record high last week, thanks largely to growing confidence in the strength of the US economic recovery and hopes for growth in Europe and Japan. Meanwhile, the blue-chip World Index has lagged behind, gaining 16 per cent in 2013.In the parlance of money managers, small-caps are known as “high beta”. This means they tend to get thumped more than bigger companies during periods of market turmoil – such as the financial crisis – but tend to do better in the longer run.

Since its inception MSCI’s small-cap index has produced annualised gains of more than 7.2 per cent, compared to the blue-chip index’s more muted annualised return of 4.8 per cent. And it is for this reason that Jim Slater, a well-known UK investor, has favoured smaller companies, quipping that “elephants don’t gallop”.

Indeed, Peter Sidoti of small-cap research specialists Sidoti & Co, argues that even the perception that smaller companies are riskier is a fallacy. “People confuse volatility with risk,” he says. “When you look historically, volatility is actually the friend of the investor. For the speculator it’s dangerous, but for the true investor it’s advantageous.”

The stars of the recent rally are a wide-ranging group. In the US, Lions Gate Entertainment, producer of television shows like Mad Men and box office hit Hunger Games, has soared almost 120 per cent this year. Boston Beer Co and Caesar’s Entertainment have also benefited from the US economic recovery and investors’ appetite for “booze and gambling” stocks.

The UK’s success stories range from retailers Debenhams and Next, which long struggled with limp consumer spending, to venerable travel company Thomas Cook, which nearly collapsed just two years ago.

Japan’s stock market has enjoyed a particularly fine year, as investors have warmed to new premier Shinzo Abe’s determination to put an end to years of deflation. But the rise of much smaller, less glamorous stocks like Sanix and Envipro Holdings is particularly striking.

The former, a pest-control firm from the southern city of Fukuoka, has risen about 420 per cent since Mr Abe took control last December. The latter, a scrap-metal merchant based in the foothills of Mt Fuji, rose more than 20 per cent this week after its Tuesday debut in Tokyo.

Although small-caps have historically outperformed, their recent resilience is nonetheless eye-catching. Smaller companies often find it much harder to raise financing even when growth is buoyant, and are usually the most vulnerable when economic conditions worsen and banks rein in lending. But, aside from a brief spike at the nadir of the financial crisis, default rates have remained subdued.

Andrew Neville, manager of Allianz’ global small-caps fund, attributes this to enforced conservativeness. “Smaller companies are actually often better financed than bigger ones, as they’ve always struggled to get bank loans,” he points out.

The question now is whether the outperformance of small-caps can continue, or whether prices are becoming frothy. Many investors tend to jump into small-caps at the tail-end of a bull market, when prices of bigger companies seem too high.

For now, investors and analysts remain bullish, and point to still-reasonable valuation metrics. Barclays predicts the Russell 2000 index of smaller US companies will rise a further 4 to 6 per cent over the next twelve months – and possibly more if the economy stays on track.

“If you believe in an economic recovery, small-caps will lead the market,” says Vadim Zlotnikov, chief market strategist at AllianceBernstein. “Profit margins for large-caps are a lot more extended than those for small-caps.”

Sam Stovall, chief equity strategist at S&P Capital IQ, advocates a more nuanced approach, using the equal weight S&P 500 where all companies count for the same regardless of size. “So you end up with a small cap-type movement, yet you have large-cap blue-chip qualities,” he says.

However, Europe may be the most attractive opportunity. Nick Nelson of UBS points out that the US recovery is further along than in Europe and the UK, so valuations are higher. “But in Europe the cycle is only turning now, and as banks perhaps start opening the spigots again and begin lending, it’s bullish for small-caps,” he says.

Mr Neville feels the European banking sector still needs some surgery before credit flows flicker back, but has nonetheless gone overweight on Spain, Italy and Ireland, and recently purchased a Greek company for the first time in five years.

“The European recovery is actually quite convincing, and the peripheral countries look less worse now,” he says.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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