Analyst estimates is a critical piece that often is ignored by the retail investor. For the institutional investor it provides an important benchmark to measure both current market sentiment and investment appetite.
Tough times ahead so where should I put my money? Market volatility continues to remain poor and macro-economic indicators continue to provide contradicting signals. Volatility a very good indicator of investor sentiment is lethargically low at 6.6% which is 10 points below its 10 year average and 43 points below its 10 year high.
Capitalisation, a terrific yard-stick in measuring the size of a company, provides essential divisions in interpreting different types of investment themes. We define the market in three slices large cap (5 billion and higher), mid cap (between 500 million to 3.5 billion) and small cap (below 500 million and below). Over the past five years small caps have dominated the major indices and since mid-2003 it has also reaped greater positive earnings momentum.
2005 will be different. Although there will be some small cap winners, in general the balance of negative factors will weigh these companies down. The initial signals are quit disturbing. FTSE small cap 2005 earnings growth has been revised down 9 points since the beginning of the year and valuations have risen to 15 times earnings and almost 2 times book value. This compares to 13.2 times earnings and 2.2 times book value for the FTSE 100. Clearly this is expensive when the group should trade at a substantial discount to large cap, particularly due its poor liquidity and low Return on Equity (a vital component in interpreting profitability). In addition macroeconomic indicators of small and medium cap performance relative to large caps are now generally more negative. In general small and medium caps are ideal investments in respect to a ‘value’/RoE theme, which is currently not the case.
Small caps are still performing strongly, partly because of the sheer size of investment flows and partly because of speculation arising from recent M&A activity. However the fear of a downturn will swing back in favour of the major indices in 2005, to the detriment of bond markets. As such in this type of environment we recommend taking profits on small caps and placing a greater allocation to large caps.
These views are independent of FactSet Inc and are proprietary to Bobby Rakhit. For the full report and individual sector reviews and recommendations please contact rakhitreport@yahoo.co.uk.