Stock market analysis: Think big - invest small, how the midcaps and AIM are winning the FTSE race

Stanley Druckenmiller has missed out on the recent rally
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STANLEY Druckenmiller, the billionaire investor sometimes called the most charitable man in America, has been humbled.

He has missed the fairly extraordinary stock market rally of the last two months, a surge that has seen billions “wiped on” to the value of companies large and small.

He told CNBC this week: "I've been humbled many times in my career….and the last three weeks certainly fits that category.”

Druckenmiller’s hedge fund is up just 3% compared to a 40% market rally, a performance he blames on underestimating just how far central banks including the Fed would go to inject stimulus into markets. Perhaps a net worth north of $4 billion will prove some consolation.

It is interesting to note which shares in particular have done well. The answer is, most of them, but there is a clear bias to smaller and mid-cap firms.

Our chart here makes the point:

The Aim All-Share has rocketed 50% since March 23, while the FTSE 100 is up a less remarkable, if still stellar, 30%.

That backs up a City belief that small-caps outperform in bull markets and economic recoveries. (They prejudice also that they underperform during bear markets and recessions).

Russ Mould at AJ Bell takes up the story: “Small caps are generally riskier than large caps because they are often more reliant on one product or service, one market or country and sometimes one key executive or individual, especially in their very early days.

"Their finances are often less robust than those of larger, more established firms and their cash flows are more susceptible to swings in demand, so they can get into financial trouble more quickly, with the result that they either dilute existing investors to shore things up when they raise fresh or they just go broke.”

The recent rally has left even some traders confused
AFP via Getty Images

But all of those factors mean their recoveries from downturns can be huge, as even a small change in sales drops quickly through to the bottom line.

By contrast large caps will have a slower rate of recovery.

Neil Wilson at Markets.com says big companies are like super tankers - they take a long time to turn around and make a lot waves when they do.

He argues: “So resetting for recession, lower earnings growth and a post-pandemic economy takes them time. Economies of scale enjoyed in the good times become diseconomies of scale in recession.”

Wilson offers these three AIM names worth watching just now:

1) Amryt (a pharma firm)

2) MPAC (packaging)

3) Renalytix AI (artificial intelligence for kidney disease)

Lee Wild, head of equity strategy at interactive investor says investors have liked promising small-cap miners, oil exploration companies and tech firms exploiting a lucrative niche, or stocks that just happen to be in the right place at the right time.

“Many of the biggest risers during the pandemic recovery phase have had a new story to fuel buying. Most notable have been the Covid-19 testing stocks like Novacyt, Genedrive and a dozen others whose shares have soared as much as 8,000% in quick time,” he adds.

“Picking these stocks requires research, courage and a lot of luck, but the promise of returns you’d struggle to find anywhere else is a constant lure for investors.”

Fed chair Jerome Powell has pumped in billions to help the US economy
AFP/Getty Images

So one side effect of the pandemic has been to remind investors that smaller companies and the markets they trade on, like AIM, have far greater growth potential than larger companies operating in more mature markets.

This route isn’t for the faint of heart. There’s greater risk involved for sure.

And many smaller companies will require new money to fund investment and growth. At the moment, that’s not a problem, but a deterioration in the lending environment could put less stable businesses at risk.

But if you feel confident about your strategy, you could do well from the smaller stocks. As Jim Slater once said: “Elephants don’t gallop.”

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