F&C’s Director of European Equities, Sam Cosh, explains: “You generally tend to get the big opportunities when things look terrifying. Now, we have a situation within Europe where valuations have risen but profits have not yet recovered.”
Going forward, he says, while there is potential for further growth it is all about whether or not companies deliver in terms of earnings.
Montanaro fund manager, George Cook, agrees that much of the easy wins have been had, but believes there is still growth to be had.
Looking over the business cycle, he said, European equities are currently edging out of the recovery phase and entering the expansion phase. “Small caps tend to do well in the expansion part of the cycle,” he says.
On average, he adds, European small caps are roughly fairly valued, but he says, you are still seeing a significant number of earnings downgrades. That needs to change if growth is to pick up.
Stockpicking matters
Both Cosh and Cooke are quick to emphasise the importance of stockpicking in the small cap space, which has a huge number of stocks and very little analyst coverage.
During periods of economic recovery (the part of the cycle from which we have just emerged) the lower quality stocks tend to outperform, Cooke says, but adds, this part of the rally is beginning to look stretched.
“The key thing in the small cap space,” Cooke says, “is the certainty premium that comes from quality companies in the space. Quality companies actually deliver on their earnings, which becomes increasingly important at this point in the market.”
Cosh agrees with this, pointing out that the market now isn’t really differentiating between quality stocks and everything else.
“The valuation dispersion is very flat at the moment. We aren’t quite at the top, when the dispersion between good and bad would be completely closed, but we aren’t too far away,” he adds.
European small cap opportunities
As valuations in the European small cap space wait for earnings to catch up, stock picking skill becomes ever more important.
