Don't carp at GARP, says F&C's Longden
2009 will go down as a good year for continental European smaller company share prices, according to F&C's Crispin Longden, Head of Continental European Small Cap Equities.
Despite an inauspicious start, the asset class ended the year with strong gains, easily trouncing those produced by larger company shares. The benchmark HSBC Smaller Europe (ex UK) Index powered ahead by 55.1% in Euro total return terms while the larger capitalisation equivalent index - FTSE World Europe ex UK - returned 30.7%.
Nevertheless, Longden acknowledges that not all stocks were swept up in equal measure amidst the renewed enthusiasm for smaller European companies in 2009.
"The sharp rally which began in early March was led by cyclical names, which experienced the steepest fall in the 2008 downturn. The predilection for these stocks was indiscriminate throughout much of the year with perceived lower quality companies - those with high debt levels and poor business fundamentals - registering the strongest gains. Companies perceived as being higher quality - possessing strong balance sheets and historical earnings stability - were left behind. This seems illogical, but accurately reflects the positive impact of artificially low interest rates on indebted, weaker companies and their ability to streamline a bloated cost base and squeeze working capital to preserve profitability", he commented. Longden anticipates that this trend will reverse in 2010 as the European economies begin a slow recovery. He believes that the easy gains in cyclical stocks have been made and that any resumption in demand may lead to escalating costs while rising interest rates expose still-fragile balance sheets.
Moreover, the heady price gains seen in 2009 have left many such stocks on rich valuations by historical standards.
Longden explained: "The chemicals sector as a whole is now trading almost 4 standard deviations above its historical norm measured back to 1981, while general industrials are more than 2 standard deviations above average.
Significantly, both these sectors were still valued above the historical norm even at the depth of the most recent downturn. Typical growth sectors such as technology and pharmaceuticals, by contrast, continue to trade well below their historical average".
In F&C's continental European smaller company portfolios, Longden is currently overweight healthcare and information technology and underweight basic industries and cyclical services.
"An investment strategy focusing on value rather than growth has been in vogue throughout the recent stockmarket turbulence. Growth can now be obtained for a reasonable price. It is time for the GARP style of investment to stage a come-back", Longden concluded.