With the midcap and smallcap stocks gaining momentum, global brokerage and research firm Morgan Stanley has turned bullish on the SMID stocks, claiming that after 30 months of struggle these could be back to outperform.
Over the last one month, when the benchmark indices S&P BSE Sensex and NSE Nifty 50 managed to gain only 2%, midcap and smallcap peers have outperformed the headline indices significantly. The S&P BSE Midcap index has gained 8.64% in the last one month, while S&P BSE Smallcap has surged 11.52%. On the Nifty, the Midcap 50 has managed to gain 9.5% and the Nifty Smallcap 50 has surged over 17%. With the midcap and smallcap stocks gaining momentum, global brokerage and research firm Morgan Stanley has turned bullish on the SMID (small and mid-cap) stocks, claiming that after 30 months of struggle these could be back to outperform.
In a recent note, Ridham Desai of Morgan Stanley said that a forward looking stock market is possibly anticipating better growth, helping the SMID stocks. Amid the normalisation of monetary aggregates and policy actions initiated, such as the corporate tax cut, Morgan Stanley says growth could now return. “Smaller firms are likely to benefit more due to their operating and financial leverage. SMID valuations are looking attractive relative to GDP and money supply, setting the stage for outperformance versus large cap stocks in the coming months,” it said.
What pulled small, midcaps down?
After gaining momentum in 2012, small and midcap stocks saw significant growth till the beginning of 2018. The MSCI India Small Cap index, which counts Apollo Hospitals, Balkrishna Industries, and Crompton Greaves as its top constituents, has since then been slipping. The Nifty midcap 50 gained 187% between January 2012 and January 2018. From then till January 2020, the index slipped 10%.
“At the end of 2017, SMIDs were trading at 50x trailing earnings, more than twice the multiple for the narrow index (BSE Sensex),” the note added. Market participants expected the small and midcap indices to beat the benchmark but that did not happen. “Growth slowed down due to a variety of factors. Broad market revenue growth went from 32% (for the quarter ended September 2018) to -5% by the end of March 2020,” the note co-authored by Ridham Desai and Sheela Rathi said. The underperformance of the SMID indices could be attributed to some tough reforms undertaken between 2015 and 2018, including the GST law, the real estate regulation act, the bankruptcy code,and the new inflation framework. Although these reforms were positive in the long-run they may have dragged earnings in the near term.
What’s changing now?
After a string of reforms that may have hit the growth of smaller firms, the onset of coronavirus only made matters worse. However, the money supply that eroded from markets in early 2017 could not be returning. Additionally, policy actions like corporate tax cuts have also helped small firms.
The note said that stock market participants have not stopped penalising the SMID stocks “We believe that the reversal in relative SMID performance, which began in April 2020, is likely to continue. Once the impact of COVID-19 ebbs, the cumulative policy response plus monetary system normalization should once again bring back growth, in our view,” it added. Valuations of the smaller firms are also looking better.
Top stock picks
Morgan Stanley is overweight on 22 stocks, with market capitalization of around $3.5 billion. Some marquee names include Aditya Birla Capital, Apollo Hospitals, Tata Power, PNB Housing Finance, Jubilant FoodWorks, Shriram Transport Finance, Jindal Steel and Power, and Mahindra & Mahindra Financial Services.
Although there are a lot of positives to be drawn, Morgan Stanley does not rule out the risk that is aligned with the spreading coronavirus. If the impact of the coronavirus deepend it could derail the growth. Along with it the financial stress that Indian financial system has been dealing with could impact borrowing which in turn hits businesses. Additionally the brokerage firm highlights that if India fails to undertake structural reforms in land, labour,agriculture, privatization,and investment it could again push investors towards large cap stocks.