UK equities: Are UK mid-caps set to shine?

Key takeaways

• Returns from UK mid-caps have shown long-term resilience.
• UK mid-caps are valued at 20% below their long-term average and offer an attractive income stream.
• Factors that could trigger a resurgence include interest rate cuts, a supportive economic backdrop and strong corporate fundamentals.

Mid-sized companies in the UK have historically offered attractive long-term returns. However, recent years have posed challenges as businesses grappled with the aftermath of Covid-19 and economic uncertainties.

Despite these hurdles, mid-cap stocks, representing both the best of domestic-focused firms and global leaders, are now emerging as compelling opportunities for astute investors. With multiple catalysts aligning, mid-cap stocks stand at the precipice of a potentially rewarding resurgence.  

Long-term resilience of UK mid-caps: An enduring trend

Charting back to 1955, UK mid-caps have demonstrated remarkable resilience. They have delivered an average real return (which accounts for the impact of inflation) of 7.8% annually, according to the Deutsche Numis Mid Cap Index. In monetary terms, this means that if you invested £1 in mid-cap stocks in 1955, it would now be worth £4,159.

This consistent performance outshines government bonds and UK large caps, underscoring the enduring strength of mid-cap companies. Despite economic and market fluctuations, mid-cap stocks have historically provided robust returns, which we think makes them an attractive proposition for investors eyeing long-term growth.

Overcoming short-term challenges

In recent years, mid-cap stocks have faced short-term underperformance amid macroeconomic challenges, including a sluggish domestic economy and rising interest rates. As a result, they have lagged their more globally oriented counterparts in the FTSE 100 and currently trade at their lowest valuation relative to large caps since the 2008 Global Financial Crisis (GFC).

However, it's essential to note that the current market landscape differs significantly from that of the GFC. Mid-cap stocks comprise a diverse array of businesses, including market leaders and globally recognized companies with robust fundamentals, often overlooked amidst short-term market fluctuations.

Moreover, they have demonstrated resilience, emerging from the challenges of the Covid era with strong balance sheets and a proven track record of profitability.

Seizing opportunities amid adversity

For investors, the current market presents an opportune moment to capitalize on attractive valuations. Forward price-earnings ratios, a key metric for evaluating stock attractiveness, currently stand at 11 times earnings, representing a 20% discount from their historical average of 14 times¹.

Additionally, the dividend yield on UK mid-caps, which measures how much a company pays out in dividends compared to its share price, is currently 4%. This is approximately 25% above its historical average of 3.2%², providing investors with an attractive income stream while they wait for share prices to rise.

Moreover, the recent downturn in mid-cap share prices, driven by concerns over economic growth, belies the underlying resilience of these companies. Despite economic uncertainties, corporate profitability has remained robust, which we think lays the groundwork for future share price appreciation.

Catalysts for future UK mid-cap growth

Looking ahead, several catalysts point towards a resurgence in mid-cap performance. Early indicators of economic improvement, including rising wages and falling inflation, bode well for consumer spending. Moreover, optimism surrounding potential interest rate cuts and positive manufacturing and services data signal a favourable environment for mid-cap companies to thrive.

Historically, mid-caps have outperformed the broader market following interest-rate cuts, paving the way for sustained growth over several years. As economic momentum gathers pace, mid-cap stocks are poised to reclaim their position as performance leaders.

Conclusion: Unleashing UK mid-cap potential

In conclusion, we believe the stage is set for mid-cap stocks to shine once again. With a supportive economic backdrop, potential interest-rate cuts, and resilient corporate fundamentals, UK mid-cap stocks are well positioned for meaningful growth. By carefully navigating short-term market fluctuations and capitalizing on attractive valuations, investors can unlock the full potential of mid-cap investing.