BRUSSELS/FRANKFURT Small engineering and luxury products companies in Europe could outperform larger competitors in the current market squeeze as the falling euro accentuates the benefits of emerging market demand.
Small-cap stocks tend to underperform larger peers during downturns and outperform during economic recoveries and since the Greek sovereign debt crisis has hit markets, small companies in Europe have lost almost twice as much as their bigger rivals.
Since April 26, when the stock market began to decline, the MSCI European Union Small Cap Index .dMIEC000S0NUS has slid 14 percent, compared with the FTSEurofirst 300 .FTEU3 which has lost about 7 percent.
But data from Thomson Reuters' StarMine suggests that some sectors in the European small-cap universe have fallen by less than their bigger counterparts, giving investors the chance of relative safety during market ructions.
"The sectors that have worked well are travel and leisure, industrials, and technology, the three sectors which are heavily weighted towards mid-caps and linked to consumption," said Florian Castel, mid-cap fund manager at Exane BNP Paribas.
He said that smaller companies were benefiting from this emerging markets consumption trend specifically because they make niche products.
"There is more discretionary consumption in small and mid caps," he said.
The euro hit a four-year low against the U.S. dollar this week, impacted by concerns over market regulation and sovereign debt.
Over the past few days, the euro has reached a 17-month low against the Russian ruble, a seven-and-a-half year low against the Chinese yuan, a two-and-a-half year low against the Indian rupee, and an eight-year low against the Brazilian Real.
Exane's Castel pointed out that since April 26, when the sell-off started, some companies have declined by much less than the general smallcap index.
Luxottica (LUX.MI) has fallen by around 6 percent, Swatch (UHR.VX) has fallen by about 7 percent and Burberry (BRBY.L) has fallen by about 4 percent.
StarMine data shows that smaller companies in the travel and leisure, and technology sectors have also performed better than their larger peers.
Over the past two weeks, small-cap stocks from the hotel, resorts & cruises industry have on average lost 1.1 percent, less than the 2.0 percent drop in bigger players, while small technology stocks have outperformed by 3.8 percent.
EVEN WITHOUT THE CURRENCY BOOST
Harry Nimmo, a small-caps fund manager at Standard Life, said that the small and mid-cap engineering sector in Britain gets a lot of its strength from its exposure to emerging markets, and this is without the currency benefits of their European peers.
"One of the big strengths has been some of the engineering sectors, mid-cap plays on the resilience in the emerging markets, in China, in the BRIC (Brazil, Russia, India, China) economies, these companies are particularly tied in there."
He picked out valve specialist Rotork (ROR.L), steam specialist Spirax-Sarco (SPX.L), measuring device maker Renishaw (RSW.L), rolling door maker Cookson CKSN.L, and belts and pulleys specialist Fenner (FENR.L).
Almost a quarter of Spirax-Sarco's revenue in 2009 came from its Asia Pacific region, while the rest of the world region represented over 30 percent of Rotork's turnover. Rotork's shares fell only 3.4 percent over the last two weeks, while Spirax-Sarco dropped in line with its smallcap peer group.
According to StarMine, 42 European small-cap construction and engineering companies have on average fallen by 8.5 percent over the last two weeks, slightly outperforming a 9.3-percent drop of a group of 20 larger peers.
Some analysts cautioned that a few of the outperforming small-cap sectors do so because of their low liquidity compared with large-cap stocks.
"Small and mid-caps can outperform in a down market, especially in rapid sell-offs, due to the 'liquidity trade' -- in times of high volatility, investors prefer to trade their larger, more liquid holdings to minimise price impact," said Anders Bergman, an analyst within the small/mid-cap strategy team of J.P. Morgan Cazenove.
StarMine data showed that Europe's small-cap utilities are down 2.3 percent over the last two weeks, less than the 3.9 percent drop in larger peers.
"My thinking is that European smallcap utilities have been suffering less under the current sell-off due to their limited presence among larger index composites, where the pressure to sell was greater than in other sectors," Claudia Panseri, analyst at Societe Generale, said.
Nevertheless, analysts point to some of the intrinsic advantages of smaller companies as reason enough to invest.
"It's the growth behind them. They can be more innovative, more independent, and in many cases offer niche products. And this is why you can still see growth in some sectors in the current sell-off," said Henning Gebhardt, head of European Small and Midcaps at DWS, the asset management arm of Deutsche Bank.
(Editing by Sitaraman Shankar)
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