The small cap recovery is on pause while investors wait for the October budget.
- The small cap recovery has lost momentum, particularly for AIM stocks.
- The rumours swirling on the October budget have dented confidence.
- Momentum could revive if the budget changes are less onerous than expected.
After the toughest of tough periods for UK small caps, there were signs of a recovery in the first half of 2024. The FTSE Small Cap showed a strong run until early August, and even the beleaguered AIM market surged higher. However, normal service has resumed since the summer, particularly for the smallest companies. Why have small caps lost momentum?
Most fund managers agree on a number of elements on small caps. The first is that they are cheap on every measure, on price to earnings ratio, on yield, on book value. The second is that there should be a long-term ‘small cap premium’ because they tend to grow faster. This has existed throughout history and there is no reason that it should have disappeared. Finally, it is that they remain unloved by investors. Inflows have yet to normalise, and price appreciation has tended to come from M&A and buybacks.
It was hoped that the recovery in share prices at the start of the year could build into real momentum for small caps in the latter part of 2024. This hasn’t happened. From November 2023 to June 2024, the AIM market saw a significant recovery, rising more than 20% . Since May, it has slipped back around 9%. The FTSE Small Cap index has fared better, but is still below its level on 1 August. The FTSE 100 is flat over the same period.
The explanation for this could be straightforward. Just as investors needed a little push to buy back in, they received a little push to sell instead. The rumours swirling on the October budget have dented confidence, even if the reality turns out to be nowhere near as bad as the expectation.
This is particularly the case for the AIM market, with the potential withdrawal of business relief robbing the market of a major source of demand. But this could also have a knock-on effect on the wider smaller companies sector. Data from Wealth Club shows that £8.3 billion is invested in AIM by UK funds, accounting for around 16.5% of the AIM All-Share Index. It says: “In the event that pulling IHT relief from AIM caused significant volatility and saw declines in valuation, these funds, including popular funds from managers like Liontrust and Marlborough, would not escape unscathed.” Liontrust UK Smaller Companies and Marlborough UK Micro Cap Growth have more than two-thirds of their assets invested in the AIM market.
It is a similar situation with capital gains tax. Some investment trusts report waning demand because individuals have large, uncovered gains. They have been selling over fears of capital gains tax rises, creating selling pressure just as recovery was getting started.
The hope for the sector is that Chancellor Reeves recognises the importance of incentivising investment in small companies and the budget does not turn out to be as difficult as expected. In that case the smoke may finally clear for UK small caps.
