The Week: Better times ahead for UK mid-caps

Yesterday’s vote in Parliament came as close as reasonably possible to preventing a ‘no deal’ Brexit scenario. Of course, in the absence of other options, there may still be an accidental ‘no deal’, but most believe that it now looks unlikely. Might this revive the fortunes of the mid-cap sector, which has been laid low by Brexit concerns?

  • The pound has rallied as a no deal Brexit becomes less likely
  • Mid caps have underperformed because of their domestic bias
  • They have already started to recover, so the discount may not persist

The large caps have outperformed since the referendum, as a weaker pound has flattered their dividend payouts and earnings. Mid-caps, once seen as the hot destination for dividend growth, have had a weaker spell. Part of their historic appeal has been their ability to grow their dividends faster than their peers, but once ‘special’ dividends were excluded, the largest 100 companies saw payouts increase by 9.3% in 2018, while mid-cap dividends manager just 1.4%.

There have been other reasons for mid-cap weakness. In addition to its earnings being more domestically-focused, mid-cap companies have tended to cluster in some vulnerable sectors such as housebuilders and retailers. These have been on the front line for concerns over the strength of the economy after Brexit. 

But the situation is changing a little. The pound has rallied somewhat since a no-deal was taken off the table, which means that a significant barrier to the relative performance of mid-caps has been removed. At the same time, the UK economy has been soldiering on. Yes, there are signs of weakness, but if politicians finally start to cooperate and deliver a workable Brexit deal, this may prove the low point.

Also, it should be noted, the mid cap sector remains an important source of diversification in any portfolio. If investors want to look beyond large banks, utilities, healthcare companies and oil miners, they need to delve into the mid-caps. While the Capita Asset Services Dividend Monitor is predicting that the mid-cap yield, at 3.3%, will continue to lag that of the FTSE 100 (5%) for the year ahead, this weakness is confined to a relatively small number of sectors within the mid-caps, notably telecoms, retail and support services. 

There are relatively few opportunities to pick up mid caps at a bargain. Now may be one of those rare moments. They have already started to rally since the start of the year.  Get them while you still can. 

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