`Small caps' beat Footsie

A NOTICEABLE feature of the past few weeks has been the sparkling performance shown by "small-cap" stocks in the FTSE 250 share index, decisively beating the Footsie index of 100 leading companies - at least until banking stocks showed signs of revival this week.

According to Perpetual's UK fund managers, Stephen Whittaker and Neil Woodford, there are three main factors driving this mid-cap performance, after almost 12 months in the doldrums.

There has been an increase in mergers and acquisition activity in the sector, which is driving up values. This bears out the view that even when the investment community has not found mid-caps attractive, the corporate sector has been buying companies.

The second reason is that interest rates remain low, a factor which is particularly helpful for smaller companies. Rates may have to fall further, partly because the economy can sustain lower rates and partly because Euro-convergence seems to be gathering pace. European interest rates are three per cent at present.

The third factor which has been driving up mid-cap stocks is a growing consensus that the recession will not be as severe as was feared. This is in contrast to earlier expectations of a marked slowdown in the economy.

Predictions of a recovery in small to mid-cap stocks, in which many fund managers invested, came to nothing. In fact, mid-caps have been comprehensively outperformed by Footsie giants for several years. Is this about to change?

Perpetual believes it may. Ian Brady, who heads the company's US desk, is also predicting a broadening of the market there, with less domination of large-cap stocks, particularly in the technology sector. He predicts a difficult six months, followed by an end to big cap "momentum" investment.

"If the small and mid- caps can't do it now, they never can," he says.