THE rally enjoyed by mid to small-cap stocks over the last 19 months came to a halt recently as market sentiment started to waver. The FBM Small Cap Index reached a 17-year high of 19,338.1 points on Aug 19, but by last Thursday, massive sell-offs had beaten it down 17.64% to 15,927.29 points. By comparison, the broader FBM Emas Index was down 7.67% from its highest point in July.
Market experts expect the downswing to continue for some time, which raises the question of whether investors in mid to small-cap stocks should divert their attention to the blue chips.
Low liquidity, which implies thin trading, is a double-edged sword for mid to small-cap stocks. In healthy market conditions, it takes only one or two funds to start buying these stocks to send their prices sky-high. In 2013, for example, the FBM Small Cap Index gained a whopping 40.42% in a year because the environment, supported by the participation of foreign funds, was conducive for buying, say market experts.
Likewise, it takes just a few funds to withdraw their investments to send these stocks tumbling. A fund manager says funds that entered mid to small-cap oil and gas and technology stocks a little too late have seen their gains completely erased. Now, those with cash are watching from the sidelines for an opportunity to buy into blue chips with solid fundamentals, he adds.
The Bursa Malaysia website reveals that mid to small-cap O&G and tech counters, such as Coastal Contracts Bhd (-28.82%), Destini Bhd (-20.34%) and Inari Amerton Bhd (-17.36%), have been on a downward trend in the last six months.
However, AllianceDBS Research head of research Bernard Ching does not believe the nearly 18% pullback in the FBM Small Cap Index is an indication of a bear market, especially compared with the 50% reversal seen during the last recession.
The head of another research house thinks the mid to small-cap stocks over-performed over the year and are now seeing strong profit-taking. He expects the market to recover over the next two months. “Recovery will come from the blue chips first, followed by the mid to small-cap stocks.”
When asked if he had noticed investors switching from mid and small caps to blue chips, he says he has seen some buying activity in telecommunications and utility stocks, which are dubbed “defensive”.
“The change in sentiment has caused prices to drop. Mid to small-cap stocks are especially vulnerable because of their (low) liquidity. It depends on whether you’re a trader or a long-term investor. We invest for the long term. So, we are holding our positions in the mid and small caps,” says Phillip Capital Management Sdn Bhd chief investment officer Ang Kok Heng, when asked about his strategy in the mid to small-cap space in these uncertain times.
Interpac Securities head of research Pong Teng Siew believes most small caps are unlikely to reach new highs any time soon because the confidence of those who trade these stocks — the retail investors — has been badly bruised. He adds that valuations in the small cap space have become expensive, although he feels they will shrink as prices decline.
The price-earnings ratio (PER) of the FBM Small Cap Index is 12.95 times whereas the benchmark FBM KLCI is trading at 16.15 times. The price-to-book value of the former index is one while for the latter, it is 2.17 times. Last year, the FBM Small Cap Index’s PER surged to 15.55 times from 8.97 times in 2012.
“There is always opportunity in a downswing but investors have to trade selectively now. The risk of investing (in mid and small caps) is so much higher than before as the stocks are not cheap anymore. Investors should wait for them to come down before buying,” Pong remarks.
AllianceDBS Research’s Ching says as valuations in the mid to small-cap space are cheaper now than two months ago, it would be easier for investors to find fundamentally sound stocks at decent prices. “It is a good time for investors with a long-term horizon to look at stocks now. Those with cash or who are under-invested should start to accumulate fundamentally strong stocks on weakness.
“I believe this is merely a correction, which is a good thing. Investors should not be too alarmed about it, but they have to be more selective because many mid and small caps have rallied purely on rumours or newsflow. Fundamentals are still important, especially now that global growth looks challenging.” — By Esther Lee
This article first appeared in The Edge Malaysia Weekly, on October 20 - 26, 2014.
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