Equity markets went through a period of consolidation between mid-May and late August: the MSCI Europe index lost more than 5% and the MSCI Europe Small Cap Index almost 4%. Although the quarterly earnings season did not produce any nasty surprises, volatility increased because of geopolitical tension relating in particular to the diplomatic crisis between the USA and North Korea. The euro’s rally against the dollar was also bad news for European exporters. This explains the greater resilience shown by European small and mid-caps during the summer, since they have less international exposure than large caps
The summer correction followed a rally of more than 10% in the major European indexes since the start of the year. However, the macroeconomic environment remains very positive in Europe. PMIs and Germany’s IfO index remain buoyant, while the economic situation is improving in France and Italy, suggesting that the eurozone economy will continue growing. Investor concerns regarding political risk have also faded since Emmanuel Macron was elected President in France. More recently, Angela Merkel’s re-election as German Chancellor ensures that European policy will remain stable.
Small and mid -caps more cyclical than defensive
As a result, the recent consolidation in equity markets is now over. The major stock market indexes are likely to resume their rally, but the context is particularly positive for small- and mid-cap indexes.
Recent current moves should continue to benefit small and mid-caps, which have a greater exposure to their domestic European markets.
In addition, cyclical and industrial stocks have been in favour since the end of the summer, and mid-caps generally have a more cyclical profile than their large-cap counterparts. As a result, the end of the summer consolidation is a good opportunity to take fresh positions in the small- and mid-cap segment. In addition, small and mid-caps operate in niche markets and are therefore less exposed to the vagaries of the global economy.
France is one of the European countries currently showing the best investment opportunities in the small- and mid-cap segment. Its economy is growing at a good rate, with GDP expected to increase 1.7% in 2017, and the pace should remain firm next year. Certain Spanish and Irish stocks are also attractive.
Small- and Mid-Cap Portfolio Manager, European Equities team