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Stock Market Week: Top 15 break away from blue-chip pack

IS LONDON turning into a three-tier market? Popular wisdom has it that in recent times the UK stock market has split into two parts, with the blue chips outperforming while their smaller peers are shunned by investors..

According to this school of thought, fund managers are increasingly reluctant to invest in mid and small cap companies, leaving a large chunk of the index starved of funds and liquidity. By contrast, investors have been piling in the FTSE 100 members, attracted by their size and global ambitions.

However, a closer look at the indices suggests there is more to the market than a clear-cut gap between the haves and have-nots.

There is a growing feeling that the biggest 15 stocks in the FTSE 100 - the likes of BP Amoco, Glaxo Wellcome and British Telecom - are breaking away from the pack, outgrowing not only the downtrodden minnows but also their smaller blue-chip peers.

A look at the indices' performance since the start of the year helps illustrate the point. There is no doubt that the smaller indices have been experiencing a bit of a revival in the new year. With global economic prospects improving and commodity prices rising, investors seemed to have regained their appetite for the undercard's cyclical stocks, such as manufacturers, oils and chemicals.

Since the start of 1999 the FTSE 250, excluding investment trusts, has outperformed the overall market by over 8 per cent, its best quarter in almost three years. The small cap, without investment trusts, has done better, beating the All-Share by nearly 10 per cent, a rise not seen in almost five years. While the undercard was soaring away, the FTSE 100 put in an uncharacteristically sluggish performance, underperforming the market by almost 2 per cent.

According to these figures, the gulf between the market's two tiers is closing, as the minnows come back into fashion. But crude numbers can be misleading. A more detailed analysis shows that the FTSE 100 underperformance is not evenly spread. The top 15 have actually done better than the rest of the market in 1999, outpacing other blue chips by some 3 per cent.

The overall conclusion is that the investors' love for big stocks that has characterised the recent bull run has not faded away despite the renewed interest in smaller stocks. Another consequence is that London appears to have become a three-tier market, with the FTSE 100's biggest 15 on top, the other blue chips and a layer of smaller stocks at the bottom.

But what makes the sweet 15 so special in the eyes of investors? Robert Buckland and Jonathan Stubbs at Salomon Smith Barney believe there are four main reasons why the big guns have managed to confine underperformance to the FTSE 100 outer reaches. For a start, they belong to in-favour sectors. The top 15 list includes six banks - HSBC, Lloyds TSB, Barclays, NatWest, Halifax and Abbey National - which have had excellent runs as economic prospects improve. There are two stocks in the high-flying telecoms sector - BT and Vodafone. BP Amoco, the largest stock in London, has also been in good form even though its rival Shell has been a disappointment. These sectors' excellent run has offset a decline in the ratings of the pharmaceutical giants SmithKline Beecham, Glaxo and AstraZeneca, whose defensive qualities have been dented by the economic soft landing.

The second attraction of the FTSE 100's biggest guns is their growth prospects. Despite being large companies, the top 15 are anything but a bunch of mature leviathans. Their recent good run has certainly put them on a premium rating to the market, but their earnings growth is expected to beat the All-Share in each of the next three years. Next year, for example, earnings per share in the FTSE 100 upper echelons should grow by around 18 per cent, compared with 14 per cent for the other stocks.

The other advantage of the largest blue chips is, quite simply, their size. After a series of mega-mergers, they account for over 43 per cent of the All-Share, a percentage set to increase to more than 45 per cent when the Vodafone-AirTouch and the BP Amoco-Arco deals are completed. This dominance, and the top 15's propensity to buy overseas, forces fund managers, especially trackers, to buy the stocks to keep their weightings in line with the index. Salomon estimates UK institutions will have to buy some pounds 59bn worth of BP, Vodafone and Zeneca (now merged with Astra) just to maintain their typical 60 per cent holding in the UK market.

The final plank of the "big is beautiful" theory is geographical mix. The top 15 tend to have large exposure to the US, where the economy is booming, and to improving markets in Asia, while they are not so hot in the sluggish European economies.

Unilever is the only member of the top tier on this week's results schedule. The Vaseline-to-Persil giant will report a slide in first-quarter profits to around pounds 630m from pounds 690m last year. A slow start of the year and a good first quarter in 1998 are major factors. After the announcement of its multi-billion pound cashback, analysts will want to know how much the Anglo-Dutch group has spent to promote products and whether it wants to bid for Reckitt & Colman.

WH Smith is on the block on Thursday. All eyes will be on the long-awaited details of the bookseller's free Internet service. The shares have soared since last month when the company announced it had teamed up with BT and Microsoft to offer a rival to Dixons' Freeserve. But while WH Smith basks in the Internet glow, its competitors have been accumulating subscribers at a hectic rate. Freeserve has now around 1.3 million customers, while Tesco, a relatively recent entrant, can count on over 200,000. WH Smith's interims should come in at around pounds 90m compared with pounds 128m last time, with sales set to be hit by the integration of the John Menzies chain bought last year.

Allied Domecq's figures, also on Thursday, will be rather grim. Both its pubs and spirits divisions have experienced a slowdown. Spirits brands, which include Ballantine's scotch and Beefeater gin, have been hit by poor trading in Mexico and the strong pound. The UK pubs will suffer from their dismal trading during Christmas. Allied's other retailing businesses, such as Dunkin Donuts and Baskin-Robbins ice-cream, should have fared better. Overall interim profits will be around pounds 300m against pounds 320m in 1998. The management will be bombarded with questions over the rumoured demerger of the drinks and retailing side of the business.

BAT, the cigarette maker, will report a fall in first-quarter profits on Thursday due to a slowdown in emerging markets and stiff competition in the US. The numbers - say pounds 340m compared with pounds 378m - will probably be overshadowed by the uncertainty over litigation.