Small-caps set to gain as interest rate cuts come through, UBS says

Yeah, there could also be some good global macro divergences. So our economists just had a report out this morning talking about the IMF meeting feedback from last week. And it seems quite clear that the Bank of Japan and the FOMC are more inclined to keep rates at more elevated levels and maybe even increase them, particularly the case of Japan. Whereas if you look at most other central banks, particularly the Bank of England and the ECB, we’re looking at cutting cycles now. Even the cutting cycles in Europe, they’re pretty benign at the moment. We’re talking a June start, maybe 1/4 point per quarter for the next year or so. It probably doesn’t move the needle. But there is this tension between the resilience of inflation and whether the economy and the jobs environment can be sustained in Europe. I think that, you know, there’s, there’s quite a lot of labour scarcity in Europe. The demographics aren’t particularly supportive of that in that we don’t have a huge amount of immigration or, or young people, you know, maturing into working age population in the same way that the US does. So there’s different dynamics around the world that are going to keep things quite interesting. I think you had spoken a little bit earlier as well about small caps and I and I just want to go into that space a little bit more, if I may just. The broadening out that we had anticipated in this market at the start of the year was based on, OK, we’re going to get an upbeat economy, right, which is hopefully the sense you get, yes, out of the US, but so too perhaps there’ll be a pick up again in Europe, which bodes well hopefully then for small caps. So if you want to broaden out that small cap portfolio should be the one you look into. Why? Why can that still not happen even though Europe is beginning to find some footing? Yes, there’s still recessionary risks and and worries, but it feels as though that small cap environment is still not the one to go into right now. It is quite a good question and we just did a piece on the UK more specifically last week that shows the small caps really are quite cheap in the UK. They cheapened after Brexit. They’ve never really recovered that valuation even though they are actually reasonably high quality and generating quite a lot of earnings growth. So they just can’t recapture that valuation. Now. You tend to get valuation expansion for small caps at the start of new business cycles when policy has turned, interest rates have come down, financial conditions are really loose and you get a really strong economic recovery. We just haven’t seen that the leading indicators give you the impression that’s underway, but not really. It’s just the leading indicators were sort of too low to start with. They sort of gave us a bit of a false signal last year. So, you know, the way that interest rates are sitting at the moment, it feels quite late cycle where at high interest rates that feel like they’re quite peak about to be cut. So you know, it’s not the environment where you get the best performance from from small and mid caps. I think that that time will come, but it’d be nice to see sort of a little bit of an economic slowdown, some of those rate cuts come through that. These financial conditions which small caps and mid caps are much more sensitive to because that’s when they’ll get their most momentum, that early stage of a new business cycle, which is quite hard when fiscal policy is tightening and monetary policy remains tight.