The FTSE 100 vs Small Caps: Which Will Win In 2016?

2015 was definitely a better year for small cap investors than it was for those sticking to blue-chip shares, with the FTSE 100 well beaten by the smaller indices — London’s biggest index fell by 9% in 2015, but the FTSE 250 gained 8% and FTSE Small Cap index picked up 4%.

Part of that was down to plunging big oil companies and plummeting miners and commodities firms — shares in Anglo American dropped 70% with Glencore coming close with a 66% loss, while Royal Dutch Shell and BP fell by 31% and 14% respectively.

But there was more to it than that, and when we see bearish markets coming to an end and getting closer to a new bullish phase, it is often smaller companies that lead the way — the kind of people who invest in smaller companies typically have a greater appetite for risk and are less afraid of the uncertainties that keep knees trembling among bigger institutional investors.

But bigger indices like the FTSE 100 typically follow not far behind and can quickly overtake their smaller counterparts. And I think there are signs that that could happen this year.

Economic growth

Firstly, the UK economic recovery is still very fragile and GDP growth did actually fall to 0.5% for the three months to September. But that was largely down to a manufacturing slowdown which was strongly affected by China’s problems, and various commentators are still expecting growth of between 2% and 2.5% for the full year.

On the back of that, interest rates are widely tipped to start rising again in 2016, with a small hike in the second quarter looking increasingly likely — and I’ll be very surprised if there isn’t a further rise later in the year. Any Bank of England thumbs-up like that would surely improve confidence in the City, and should get more investment cash flowing back into shares in the medium term (even if in the very short term it would make cash on deposit slightly more attractive).

That should give the UK’s banking sector a boost, and I see at least two banks that I reckon are irrationally undervalued right now — Barclays and Lloyds Banking Group, on low P/E multiples but with growing dividends. And a financial strengthening should help the FTSE’s big insurance companies too.

Oil recovery?

The other big drag, of course, is the price of oil. Brent Crude has just fallen below the $35 level for the first time, and as I write it’s trading at just $34.92 per barrel — and it could well go lower before it recovers, with some analysts suggesting $25 or less. But even “open the flood gates” Opec is predicting a recovery to $70 by 2020, and with the oversupply starting to be cut back I can easily see $50 by the end of 2016.

And if that comes about, it will certainly help our two big oil giants. At the same time, it would give a boost to small oil explorers and the smaller cap FTSE indices, but the greater weighting should give the FTSE 100 the advantage.

What about the miners? Well, that’s tough to call, and China’s structural problems are turning out worse than many of use expected. But commodity prices must surely be close to a bottom, mustn’t they? I just don’t see another year so bad for the miners — and their weighting on the FTSE has already been significantly lowered.

So, a year from now, I really can see the FTSE 100 coming out on top.

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Alan Oscroft owns shares in Lloyds Banking Group. The Motley Fool UK has recommended Barclays and Royal Dutch Shell. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.