Friday Highlight  

Assessing impact of Covid-19 on UK mid caps

Assessing impact of Covid-19 on UK mid caps
 Chris Ratcliffe / Bloomberg

The United Kingdom is in a phase of reopening businesses and economies, trying to get life back to some form of normality as lockdown restrictions continue to ease.

The next few months will be crucial as businesses and consumers adapt to a new way of life, and we expect to get a better picture of employment and the path of recovery when many fiscal and monetary schemes potentially come to an end.

Companies are already talking about restructuring, and many individuals could face the reality of permanent job losses.

There are two potential scenarios we could see regarding the recovery from here.

Additional wave risk

There is a heightened risk of additional waves of infections as we head into autumn and winter, which could cause a setback in the recovery we’ve seen so far.

Or, the outbreak could weaken and the recovery continues to gather pace as consumers feel more comfortable going out and getting back to work—and thus spending more.

The initial post-lockdown economic data so far seems to be showing a faster-than-expected recovery, but whether it’s based on short term pent-up demand or more sustainable demand that pulls businesses out of the downturn remains to be seen.

That said, there are signs that governments are ready to keep the taps turned on in terms of fiscal support, which we think should be supportive to the market.

Data points don’t tell the whole story

The mid-market area of the UK market (represented by the FTSE 250 Index) has underperformed relative to the wider market during the first half of 2020, bearing the brunt of the pandemic-driven volatility and uncertainty.

The chart below illustrates that UK mid caps were the worst-performing area of the UK equity market, declining more than large caps (the 'blue-chip stocks') and even small caps.

Source: Bloomberg

 

Why was that the case?

The heightened risk-off period during February and March encouraged a flight to liquidity, namely perceived safe havens and defensive stocks.

There’s a greater domestic bias to mid caps, greater cyclicality in the sub-sector constituents and there are fewer defensive stocks such as the health care, food and utility stocks which you find in the FTSE 100 Index.

As such, there was a liquidity squeeze in mid caps amidst the scramble for more liquid assets.

However, the underperformance of the headline index we’ve seen year to date doesn’t tell the whole story of the mid-cap space.

We’ve seen some interesting underlying market dynamics within the market moves. There’s been a large variation in style; not all stocks have been treated the same. Stock dispersion has been quite high even within the mid-cap universe.

Demand for growth stocks

We’ve observed stronger performance for stocks that are more growth-orientated or that could be classified as structural growth stocks or growth compounders.