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2010 is the year for small caps

AFTER small caps’ excellent 2009, many were left wondering whether such a performance could be repeated in 2010. Neil Hermon, portfolio manager of the Henderson Smaller Companies Investment Trust, certainly thinks so.

Hermon says that smaller companies have the ability to outperform this year thanks to a weak sterling and improved mergers and acquisitions (M&A) activity. He adds: “I expect the market to be choppier this year with plenty of headwinds but the cost cutting done by firms as a result of the downturn means they are leaner and are operationally geared to the upturn.”

After a quieter period during the downturn, M&A is back and Hermon thinks it will be a boon to small firms. He says: “Anticipated government spending cuts will result in greater outsourcing opportunities and this is an area where I anticipate a lot of M&A activity to occur as groups strive to gain scale and additional competencies to win contracts.”

The trust is positioned towards industrials, electronics and media stocks and, due to the prevailing macroeconomic conditions, away from consumer firms. Hermon’s favourites include specialist chemicals manufacturer Victrex and business-to-business publisher Informa.

In terms of geographical bias, the trust is skewed towards companies that have significant overseas earnings exposure. More than half of the sales in the portfolio’s underlying companies come from overseas, with a heavy bias (18 per cent) towards Asia and other emerging markets.

Hermon and his team have researched their stocks thoroughly, investigating the cash flow performance, the management team and its strategy. Contracts for difference (CFDs) traders have to be prepared to do the same and be a lot more hands on than when trading FTSE100 companies, says WorldSpreads’ Alastair McCaig.

Newsflow tends to move these stocks, so the greater liquidity in the market around an announcement are a golden opportunity for investors to trade these stocks, McCaig adds. Some CFDs traders will use these times to their advantage, jumping in and out of the market to capitalise on the latest announcement and will only hold their position for a short time.

An alternative strategy is to take a longer-term view. You hold onto a stock in the hope that the company will announce a new find or the next miracle drug before selling your position. M&A activity can also provide long-term traders with an opportunity to take profits on their position.

Provided you do your homework, there’s no reason why a small company shouldn’t mean big profits.

CFD ANALYST PICKS

TECHNICAL STRATEGIST
JOEL KRUGER
My pick: Sell crude oil at $79.50
Expertise: Technical analysis
Average time frame of trades: 5-10 days
The market is stalling in the $80 area, close to the 78.6 per cent Fibonacci retracement from oil’s 2010 lows reached in February. The area around $80-$82 acts as a solid internal range resistance, which should halt the oil price moving above this level. Due to this, we look for the oil price to trade in a range before heading lower once again, back down towards $70 in the near-term. Sell crude oil at $79.50 for a $70 objective with a stop at $84.25.

TECHNICAL STRATEGIST
JOHN KICKLIGHTER
My pick: Short 10-year German bund below 123.75, remain short oil at $80
Expertise: Fundamental and technical analysis with risk management
Average time frame of trades: 1 day–1 week
Risk appetite has firmed up over the past week and has helped growth-sensitive assets to move higher. For my existing short oil position, this raised the possibility of a break to 16-month highs. The only index not able to perform well was the Hang Seng, prompting me to exit at my break-even point. This week I have set an entry order for a short bund position on a break below 123.75 with a stop of 124.60 and an initial target of 122.70.

TECHNICAL ANALYST
ILYA SPIVAK
My pick: Short gold at market price of $1,136.15
Expertise: Global macro, classic technical analysis
Average time frame of trades: 1 week-6 months
The gold price has been unable to break above a significant resistance level in recent trading sessions. This suggests a bearish scenario for the precious metal in the near future. Expectations that the Fed will hike interest rates by 25-50 basis points within the next six months could send gold prices lower, as it would quell fears about inflation. Sell gold at $1,136.15, targeting $1,088.13. Activate stops on a daily close above $1,142.76.