A score of Australian small cap stocks have made spectacular gains this year, lifting the performance of the small cap index above the large caps. It’s been a great six months or so for investors in companies like a2 Milk Co and Wisetech Global but a couple of leading equity strategists argue it won’t last.
UBS equity strategists Dean Dusanic and David Cassidy believe “sustained outperformance from here is unlikely.”
“Small caps are trading at near price-earnings parity, which is well above historic norms. The last time we were in this situation, in early 2012, small caps underperformed heavily over the following 12 months,” they say.
Dusanic and Cassidy say the driver of small cap outperformance has been relative valuation re-rating, rather than relative earnings outperformance.
“Investors appear to be chasing the promise of higher medium-term growth in earnings per share from small caps. This may be a function of the perceived stagnant EPS growth outlook for many key large cap segments of the Australian market.”
Within small caps, the stocks that have performed strongly include those with leverage to the China consumer theme, a select group of IT stocks and some mining services companies.
Among consumer staples, the standout stock has been a2 Milk Co, followed by Costa Group Holdings, Bellamy’s Australia, Bega Cheese and Blackmores. A common theme is exposure to China.
IT stocks that have rallied strongly include NextDC and Wisetech Global
Year to date, a2 Milk is up 229.9 per cent (on a total return basis), Wisetech Global is up 114 per cent, Costa Group 107.3 per cent, Bellamy’s 76.8 per cent, Bega Cheese 76.4 per cent, Blackmore’s 67.5 per cent and NextDC 44.8 per cent.
Over the past few months, the aggregate small cap index, the small industrials index and the small resources index have all outperformed, Small industrials have had a particularly sharp rise since early October.
There have been a number of short-term periods of outperformance by small cap industrials, compared with large industrials in recent years but the long-term trend is one of underperformance.
This is borne out by Morningstar data, which shows that the small cap index, the S&P/ASX Small Ordinaries (total return), is up 10.6 per cent over the six months to the end of October, while the S&P/ASX 200 is up just 2 per cent over the same period.
However, over five years, the S&P/ASX 200 is up 10.3 per cent a year on average, while the small caps are up 6.1 per cent a year. And over the past 10 years, the S&P/ASX 200 is up 3.2 per cent a year, while the small caps are down 1.3 per cent a year.
The Morningstar data also shows that small caps are more volatile than large caps. Over the past 10 years the standard deviation for the S&P/ASX 200 has been 14.2 per cent a year, while the standard deviation for the Small Ordinaries has been 19.5 per cent a year.