It’s been a difficult couple of years for financial markets, albeit the last month or so has provided some green shoots of optimism with inflation continuing to fall and interest rate expectations moderating. Few places have been hit as hard as the UK small- and mid-cap markets with the Numis Smaller Companies Index – which covers the bottom 10% of the UK main listed market – down over 30% from its peak during the pandemic.
Valuations (i.e. how “cheap” or “expensive” share prices are in comparison to the aggregate profits they generate) in the UK “small cap” market are illustrated by the following chart from the asset manager Montanaro:
Current valuation levels are in line with the nadirs from 2003, 2009 and 1992. All those periods proved to be good entry points into UK small cap. Indeed, recent months have seen numerous takeovers of UK smaller companies: notably chocolate shop Hotel Chocolat and pub company, The City Pub Group, both for meaningful premia over their share prices. It is clear that there is a significant amount of value in UK small cap and the market is showing some tentative signs of revival.
There remains the possibility of a recession in the UK as the impact of higher interest rates bite on households and businesses. A recessionary environment could well see further weakness for UK smaller companies as they tend to be relatively more sensitive to the economic cycle, but valuations are already discounting a lot of bad news.
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