Mid and smallcap shares have lagged large-caps in the last three months. The Nifty Midcap index returned 1.8% in the period under review while the Nifty Smallcap index was up 3.7% during this period. In comparison, the Nifty 50 returned 5.6%.
The latest rally in the markets is driven by FPIs, which typically concentrate on the top 100 stocks. This has resulted in a disproportionate rally in the largecap names.
FPIs purchased stocks worth $4.4 billion in November after offloading stocks worth $900 million in the previous two months. The recent recovery in inflows is driven by expectations that the US Federal Reserve would slow its pace of interest rate hikes.
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“Markets have become selective within the mid and smallcap segments. Valuations are elevated and the recent results do not justify the rich valuations,” said Deepak Jasani, head of retail research at HDFC Securities.
In P/E terms, the Nifty Midcap 100 now trades at a 23% premium to largecaps, whereas the Nifty Smallcap 100 trades at a 16% discount to largecaps, according to a recent note by Motilal Oswal Financial Services.
According to Jasani, the current situation may continue for another month and a half till local investors make enough money in largecaps and turn to the mid and smallcap space again. This is provided the rally in largecaps continues and there is no adverse event globally.
Domestic institutional investors such as mutual funds have been net buyers for most of this year on the back of sustained inflows from retail investors that include systematic investment plans of Rs 12,000 crore every month.
A sharp cyclical recovery, evident in 16-17% credit growth, 20-25% GST collection growth and clean balance sheets of most banks and companies, is perceived by investors and economists as the strongest tailwinds for the economy and corporate earnings, according to a recent note by BNP Paribas.
Morgan Stanley strategists said better earnings due to higher capex and benign material prices, moderation in the rate hike cycle by central banks in early 2023 and ebbing macro risks support the case for an upside to the Indian equities. It made a bull-case scenario for the Sensex to hit the 80,000-mark by the end of the next calendar year.
Analysts believe that niche sectors and themes such as travel and tourism, QSR, retail, building materials and defence could see interest from investors in the mid and smallcap space going forward.
Mid and small-cap segments typically take a bigger knock than largecap stocks when market conditions turn adverse. In 2018, mid and smallcap shares tanked between 12% and 20% on an average, leading to panic among investors. Experts advise investors to limit their exposure to such stocks to 30-35% of their equity portfolio, given the headwinds in the form of rate hikes by central banks globally, geopolitical tensions and economic slowdown.