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Lower inflation, an interest rate cut and a new government may be catalysts for UK small and mid-cap stocks.
October 2024
This is a marketing communication.
Shifts in the global and domestic macroeconomic environment—and a market rotation out of large cap technology companies—are putting some wind in the sails of small and mid-cap stocks. In the US, the Russell 2000 index of small cap companies significantly outperformed the large cap S&P 500 Index in July while the UK’s mid cap FTSE 250 Index beat the large cap FTSE 100 by a similar margin.1 The recent strong performance has boosted the AIC UK Smaller Companies sector, which has returned 25% over the past 12 months (to 22 July), making it one of the best performing sectors over this period. What’s behind this change?2
The long-anticipated interest rate-cutting cycle appears to have begun. Inflation has been coming back down toward target rates across the US, Europe and the UK and central banks are signaling or starting interest rate cuts. The European Central Bank cut its key rates by 25 basis points (bps) in June and the Bank of England followed suit with a 25bp cut to 5% on 1 August, its first reduction since 2020. The Federal Reserve is widely expected to cut US interest rates in September, especially following a weaker than expected jobs report at the beginning of August.
In the UK, falling inflation, higher wages and positive sentiment around the beginning of a rate-cutting cycle could boost consumer confidence and spending. The UK economy relies heavily on services, which means that consumer confidence is crucial to driving economic growth. While the UK consumer has already demonstrated impressive resilience in the face of rapidly rising costs and interest rates, increased confidence would be an additional tailwind.
Changes in the domestic macroeconomic environment can also have a greater impact on smaller companies, which tend to be more domestically focused than large cap companies.
Small cap companies are often associated with growth and many can indeed grow through all types of environments. However, current exceptionally low valuations in the UK mean that many high-quality companies with strong fundamentals also offering good value.
The UK equity market has been trading at around a 44.17%3 discount to international markets.4 At points of the year the mid-cap index has been trading at a discount.
These small cap valuations look particularly attractive as earnings reports from several large cap bellwether technology companies, including Intel and Amazon, disappointed investors. Higher valuations for many large cap tech companies have left their stocks more vulnerable.
The UK is not only ahead of the US on rate cuts; it’s also already completed a major political election— and with a clear and unsurprising result. Investors may find the relative political stability of the UK attractive in a global geopolitical environment that includes uncertainty around the US presidential election, heightened tensions in the Middle East and a continuing war in Ukraine.
The changing macroeconomic environment—notably lower inflation and the beginning of interest rate cuts—and relative political stability in the UK provide an accommodating backdrop for smaller UK companies. Combined with exceptionally low valuations and rotation out of large cap tech stocks, UK small and mid cap stocks look attractive at current levels. Smooth sailing is never a guarantee, but the winds look favourable for UK smaller companies.
This is a marketing communication and as such the views contained herein do not form part of an offer, nor are they to be taken as advice or a recommendation, to buy or sell any investment or interest thereto. Reliance upon information in this material is at the sole discretion of the reader. Any research in this document has been obtained and may have been acted upon by J.P. Morgan Asset Management for its own purpose. The results of such research are being made available as additional information and do not necessarily reflect the views of J.P. Morgan Asset Management. Any forecasts, figures, opinions, statements of financial market trends or investment techniques and strategies expressed are unless otherwise stated, J.P. Morgan Asset Management’s own at the date of this document. They are considered to be reliable at the time of writing, may not necessarily be all inclusive and are not guaranteed as to accuracy. They may be subject to change without reference or notification to you. It should be noted that the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Changes in exchange rates may have an adverse effect on the value, price or income of the products or underlying overseas investments. Past performance and yield are not reliable indicators of current and future results. There is no guarantee that any forecast made will come to pass. Furthermore, whilst it is the intention to achieve the investment objective of the investment products, there can be no assurance that those objectives will be met. J.P. Morgan Asset Management is the brand name for the asset management business of JPMorgan Chase & Co. and its affiliates worldwide. To the extent permitted by applicable law, we may record telephone calls and monitor electronic communications to comply with our legal and regulatory obligations and internal policies. Personal data will be collected, stored and processed by J.P. Morgan Asset Management in accordance with our EMEA Privacy Policy www.jpmorgan.com/emea-privacy-policy. Investment is subject to documentation. The Annual Reports and Financial Statements, AIFMD art. 23 Investor Disclosure Document and PRIIPs Key Information Document can be obtained in English from JPMorgan Funds Limited or at www.jpmam.co.uk/investmenttrust. This communication is issued by JPMorgan Asset Management (UK) Limited, which is authorised and regulated in the UK by the Financial Conduct Authority. Registered in England No: 01161446. Registered address: 25 Bank Street, Canary Wharf, London E14 5JP.
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