Rebound in Small- & Mid-Caps?
We’re seeing a paradigm shift. Long rates are beginning to ease and are giving the equity markets—particularly small- and mid-cap growth stocks—back their appeal.
The first half of 2022 marked the end of a long period when listed companies benefited from constantly declining interest rates, which helped their valuations rise. Fears surrounding a lasting, self-sustaining increase in inflation have led central banks to significantly tighten monetary policy. As a result, interest rates have risen extremely quickly: the German 10-year yield rose from -0.2% to +1.5% in the space of six months, and the US 10-year yield climbed from 1.6% to 3.1% over the same period¹.
High-multiple growth stocks have been especially impacted by this interest rate trend. As such, in the space of six months, the valuation of our long-standing strategy, which invests in high-quality, European small- and mid-cap growth stocks, returned to its late-2017 multiples of 13.9x EBITDA². The long-term fundamentals of the companies in the portfolio haven’t changed, although some short-term pressure on margins and growth trends may appear. This isn’t what we’re seeing at the moment, with average earnings forecasts for this strategy up slightly year-to-date.
While inflation and rising interest rates have dominated the headlines in recent months, we’ve been seeing a paradigm shift for a few weeks now, with growing concerns over global economic growth. The complete shift in monetary policy could reverse the trend in demand, which was running in overdrive during COVID, creating severe imbalances between supply and demand which are behind some of the current inflation. This phenomenon is already being seen in the United States, where many retailers have issued profit warnings as they reduce inventory and offer promotions due to sluggish demand.
This situation should give some breathing room back to central bankers, who may be able to reduce their outlook for short-term rate increases. Faced with this new paradigm, long rates are beginning to ease and are giving the equity markets—particularly growth stocks—back their appeal.
As such, the environment may prove to be more favourable for our strategy, which invests in financially solid, profitable companies that are resistant to cyclical fluctuations. In recent years, these companies have shown their ability to increase their earnings over the long-term through growth positions³.