US smaller companies continue to outperform large caps

Richard Wilson, US Equities Fund Manager at Threadneedle comments: "American smaller companies outperformed their larger brethren - over the three months to 18 August 2008 the Russell 2000 Index has moved ahead by 0.11% in contrast to a fall of 10.3% by the S&P Composite Index.

"On the face of it, this out performance of small caps seems anomalous given that their fortunes are so closely tied to the health of the US economy, which clearly remains under downward pressure. The current credit crunch continues to make it challenging for smaller companies to secure funding to maintain their growth trajectory, and raising capital in the financial markets has become more difficult.

"In comparison, many large US multinationals continue to have both healthy balance sheets and cash flows as beneficiaries of strong export growth, aided by the weakness of the dollar and robust demand from emerging market economies. However, this helpful scenario has begun to change as the dollar strengthens against other leading currencies. This has helped sentiment towards smaller companies that tend to have less exposure to overseas revenues.

"Additionally, the S&P 500 Index has a large exposure to energy companies which have fallen back from their recent highs as the oil price has slipped from the record levels seen just a few weeks ago. With its slightly larger weighting in financials, the Russell 2000 Index has a benefited from the boost in sentiment following the government's recent measures to curb short selling. Some of the small cap financial institutions have fared much better than a number of leading US banks, which have seen sharp declines in their share prices this year.

"In summary, recent months have seen acceleration in the slowdown in economies outside the US and this is expected to have an adverse impact on the major US exporters, likewise the recent strengthening of the dollar will also reduce the competitiveness of US exports. Smaller companies are more reliant on the domestic economy and continue to obtain a greater proportion of their revenues from customers in the US.

"Looking ahead, it is questionable as to how long the recent outperformance by smaller companies can be maintained, given that the US economy is expected to slow further over the coming year. Nevertheless, within Threadneedle's portfolios we continue to find attractive niche growth opportunities within this segment of the market."