Analysts: Small caps may underperform market in 2012

PETALING JAYA: The small-cap sector, which continued to fumble in the recent third-quarter results season, could underperform the market next year if the flight to safety accelerates.

According to CIMB Research, if the global economy continued to deteriorate over the next few months, it was likely that the small-cap sector would underperform relative to the big caps because of the flight to quality.

“Furthermore, the long-term technical indicators for the FBM Small Cap Index (SCI) suggests that the index will consolidate in 2012,” it said in a report yesterday.

CIMB Research said that while there was no denying that small-cap valuations were cheap, investors currently had a small appetite for risk.

“The sector’s average calendar year 2012 price earning ratio (PE) of 9 times looks attractive, being at a 30% discount to the FTSE Bursa Malaysia (FBM) KLCI’s PE ratio. The small-cap sector usually trades at discounts of between 25% and 35% to the FBM KLCI.

“But we think that the discount could widen if the flight to quality accelerates over the next few months,” it said.

The SCI is lagging behind the FBM KLCI, having fallen 8.5% at the end of November compared to a 2% decline for the FBM KLCI. The SCI peaked in early 2011 and has been sliding gradually since then.

But, from the end of September, the SCI’s recovery has been a little stronger than the FBM KLCI’s, at 11% compared to 7% for the FBM KLCI.

“We also note a lot of retail interest in selected penny stocks over the past two months,” it said.

A research house head told StarBiz that if the market was flat for some time (two to three weeks), then there could be selected interest in small-cap counters, but if the market was generally on an uptrend, then the whole small-cap sector could be attractive.

“Usually after a month of the big-cap rally, interest would shift to small caps.

“But, I do not foresee this to happen in the first six months of next year,” he said, adding that the limelight for first few months of 2012 would be on the big caps.

CIMB Research said one of the main reasons for the small-cap sector’s underperformance this year was result misses.

“The best quarter for small-cap stocks was in the third quarter 2010 (calendar year). Since then, corporate results have been deteriorating,” said CIMB Research.

In the recent third-quarter 2011 results season, CIMB Research said none of its small-cap stocks beat its expectations and 53% fell short of expectations, worse than the 35% ratio of underachievers in 2Q11.

“We still see no signs of a turnaround. In fact, earnings could worsen in 2012,” it said.

“Generally, the managements of small-cap companies are finding it challenging managing their companies, given the extreme volatility in raw material prices and also the forex market. The economic slowdown in the United States and Europe also has both a direct and indirect economic impact on these companies,” it said.