Week Ahead: Why the mid caps have a spring in their step

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The Independent Online
AS blue chips dilly and dally, the stock market's supporting shares, ranging from pounds 2bn-plus groups to the tiddlers unable to muster a pounds 1m capitalisation, are enjoying a spring-time romp.

There is a growing feeling in some quarters that Footsie may have already achieved its highest level of the year. But the rest of the market is stretching to new peaks and there is confident talk of yet more high ground being taken.

Richard Jeffrey, strategist at Charterhouse Tilney, says "in all probability" Footsie has peaked. He observes: "On both sides of the Atlantic clouds are looming. The odds on an increase in US interest rates are rising steadily and a further tightening remains probable in the UK.

"While not catching the markets entirely off-guard, such action will mark the end of the positive phase of the economic and stock market cycles."

Robert Fleming Securities is one banking on non-Footsie shares continuing to outperform. It believes the mid cap revival is "well placed".

Mid caps, as represented by the FTSE 250 index, for long limped behind Footsie, only starting to challenge the gap which opened up towards the end of last year.

This year they have enjoyed remarkable strength, often outperforming their peers.

Fleming say earlier mid cap rallies were "undermined by negative earnings performance, and they failed.

"However the last year has seen a different story; earnings are rising strongly relative to Footsie but the price relative has been stuck around the old lows.

"So the gap that has opened up is a more positive one for the sector. This means the FTSE 250 is now on a p/e discount to Footsie and is showing superior earnings growth."

The mid cap index closed at a 5,741.1 points peak on Friday and the small cap also hit a record high, 2,704.6. Footsie, however, ended at 5,969.8 against its 6,105.8 high, hit in April.

Why have the second- and third-liners staged such a dramatic comeback? There are many and varied explanations.

The valuation gap opened up between Footsie and the rest has became increasingly difficult to justify and investors, particularly institutions, started shopping on the market's undercard.

Indeed the value which lurked outside the top 100 shares was illustrated by the fancy takeover prices paid for a range of companies with overseas and even domestic groups prepared to ladle out cash.

There is also the simple fact that Footsie's progress owed much to the financial sector as institutions built their weightings to accommodate the arrival of the former building societies. However with rumours of mega financial bids failing to become reality the sector has since faltered.

Still one financial merger which did materialise was on the insurance pitch, with Commercial Union getting together with General Accident to create CGU and not, as some wags suggest, Commercial Accident.

Still, merged groups which initially opt for initials have been known to suddenly produce a daft name. Witness Grand Metropolitan and Guinness. Originally it settled for GMG Brands only to spring Diageo on an unsuspecting market.

The CGU constituents are among the blue chips on this week's profits schedule. They will not have a particularly happy profits tale to relate when they report their first quarter profits.

CU is expected to post an operating profit around pounds 60m, down from pounds 102m in the same period last year. GenAcc should produce pounds 45m against pounds 114m. So combined profits will be more than halved.

The two will have suffered heavy hits from storms in the US and Canada and fierce competition in key markets.

The pounds 15bn merger, although cleared by the Eurocrats of Brussels, is not due to be completed for some weeks. However, the two groups are already taking in some of the trappings of the merger by holding joint analysts and press meetings.

Body Shop International should indicate profits progress after three indifferent years. The market expects around pounds 38m which would compare with pounds 31.7m.

If such hopes are realised it will represent welcome relief for the hard- pressed environmentally aware cosmetics group. In March its dismal share performance resulted in it being relegated from the mid cap index. Six years ago the shares were riding at an exotic 370p. By March they had fallen to 111p. On Friday they were trudging along at 119.5p, capitalising the group at pounds 230m.

Like so many other British groups, Body Shop has suffered in America. A disastrous foray has cost it dear, not only in balance sheet terms but in market sentiment. Earlier this year the man called in to revive the 290-shop chain quit after just 17 months in the job.

Founders Anita and Gordon Roddick have now, it seems, grasped the US nettle. They are looking for a partner to help run the operation but many suspect they may find their best course will be to retire, as gracefully as possible, from the US market. After all the Brits have had plenty of practice at being forced to surrender their US commercial ambitions.

Safeway, another struggling retailer, will produce lower profits; around pounds 375m against pounds 430m is the guess.

Others due to report this week include the insurance broker Sedgwick which should manage slightly lower three month profits of pounds 40m. However the group has to contend with a pounds 35m hit from clearing up pension misselling.

BOC, the chemical group, should offer half year profits of around pounds 87m, a 23 per cent fall.