The Columbia Threadneedle UK small and mid cap team is expecting a boom in merger and acquisition (M&A) activity to help boost valuations despite growing concerns over the state of the domestic economy.
Economic data has presented a mixed picture this year even as stock markets continue to rise. Consumer confidence and retail sales have both dipped sharply, but then recovered, while GDP has slowed and PMI data has also deteriorated.
However, share price returns for domestically-focused mid and small-cap stocks have picked up pace in 2017. The FTSE 250 and Small Cap indices have returned 12 and 11 per cent to date, compared with 7.4 per cent for the FTSE 100.
Columbia Threadneedle duo James Thorne and Matt Evans noted that weaker post-Brexit valuations in the small and mid-cap space had led to a spate of M&A activity. They said smaller stocks’ recent outperformance could continue in light of this trend.
Mr Evans added that mid-cap stocks were on a high single-digit discount to peers towards the end of 2016, and remained undervalued.
“[The gap] hasn’t closed completely,” he said.
“In a low growth environment and with sterling weak there are reasons to think that if the market doesn’t get re-rated by investors, corporates will [engage in M&A].
“In this space there is a lot of opportunity to reinvest [capital]. It is not the case of international companies coming in; it’s where [companies] have taken opportunities to buy businesses that are extremely well run at depressed valuations.”
The pair said 21 stocks in their £209m UK Smaller Companies and £117m UK Mid 250 funds had either been taken over or involved in M&A activity in the last year.
Mr Evans said: “We expect that to continue in our market, and there is a lot of value sitting around. M&A will be relatively buoyant.”
The duo also remained relatively upbeat of the state of the UK domestic economy, and rejected growing concerns from economists over the ability of the UK consumer to weather macroeconomic headwinds.
Consumer spending levels dropped in the first quarter 2017, but have picked up pace in the second quarter, according to Capital Economics.
However, this in itself had added to concerns over household debt and unsecured lending – which grew 10.3 per cent in the 12 months to the end of April.
The forecaster said this would increase fears over the consumer’s ability to continue supporting the overall economy.
Mr Thorne took an optimistic tack.
He said: “The surveys have said the UK consumer is losing confidence, but we have felt that, since the Brexit vote, the soft data was misleading and people are being led by the media. The reality is they have done different.
“The outlook for the consumer is very positive.”