At record high! Mid and small-cap indices witness incredible bull run; should you still buy or stay cautious?

There is no stopping the rally in mid and small-cap stocks. The broader markets have been consistently hitting new peaks in September, massively outperforming the benchmark indices. Even though the benchmark Nifty is also at its record high, the bull run in the mid and small-cap stocks is unparalleled.

The Nifty Midcap and Nifty Smallcap indices have surged almost 28 percent and 29 percent, respectively, in 2023 so far as against a 10 percent jump in Nifty. Both these indices have outperformed benchmark indices for the 7th straight month in September.

Meanwhile, in the last one year as well, the Nifty Midcap and Nifty Smallcap indices have rallied over 24 percent each versus an over 11 percent gain in Nifty.

Just in today's deals (September 12), the Nifty Midcap 100 index hit another record high of 41,686.75, breaching the 41,000 mark for the first time ever. Similarly, the Nifty Smallcap 100 index also hit its latest peak of 13,079.20, crossing the 13,000 level for the first time.

From its 52-week low of 29,200.20, hit in March 2023, the midcap index has surged around 43 percent. Whereas, the Nifty Smallcap index has soared over 50 percent from its 52-week low of 8,682, hit in March 2023.

The midcap index has been positive in 6 of the 9 months so far this year. It was in the red in the first 3 months of the year. It rose the most in May, gaining 6.19 percent and shed the most in Jan, down 2.64 percent.

The trend is the same for the smallcap index. It rose in 6 of the 9 months so far this year and fell in the first 3 months of the year. It rose the most in July, gaining 8 percent and shed the most in Feb, down 3.64 percent.

Most experts noted that mid and small-cap stocks have performed better than largecaps in recent months. After correcting earlier this year, the broader market stocks had favorable valuations which led to rising investor interest. But now that valuations of mid and smallcaps have recovered strongly, they advise investors to remain cautious before heavily investing in these stocks. Experts suggest investors to take a stock-specific approach if they wish to accumulate more stocks from this space.

Constituents

In 2023 YTD, REC and PFC from the Nifty Midcap 100 index gave multibagger returns, surging 115 percent and 103 percent, respectively, followed by Aurobindo Pharma - 98 percent and Polycab India - 94 percent. Linde India and PB Fintech also advanced 78 percent and 73 percent, respectively. Meanwhile, Lupin, ABB India, Persistent Systems, and Trent surged over 50 percent each.

In the small-cap index, 6 stocks gave multibagger returns in 2023 YTD. Mazagon Dock rallied the most, 167 percent, followed by Zensar Tech at 148 percent, BSE at 143 percent, Cyient at 122 percent, Suzlon Energy at 115 percent and Jindal Stainless at 111 percent. Apart from them, MRPL, CE Info Systems, Praj Industries, MMTC, Firstsource Solutions, Welspun, Intellect Design Arena, Glenmark Pharma, KEI Industries, Birlasoft, KPIT Tech, CreditAccess Grameen, Amber Enterprises, JB Chemicals, and IDFC jumped over 50 percent each this year.

What experts suggest now:

Elara Capital

Nifty mid-cap and Nifty small-cap indices have a long-term history of significant outperformance over the Nifty 50 index (6.1 percent and 3.3 percent annually respectively, in 10 years). The small-cap index has under-performed Nifty in the past five years while midcaps' 5-year outperformance is still below its 10-year outperformance.

Though CY23TD outperformance of 17-20 percentage points (annualised 28-32 percentage points) may likely indicate an overheating in mid-cap and small-cap stocks and an approximation to the peak performance, the recent large outperformance is only a swing-back from the extreme under-performance seen through 2018-2022. In the past five years, the Nifty Midcap index has outperformed the Nifty 50 index by 5 percentage points and Nifty Smallcap index has underperformed by 2 percentage points, annualised. Thus, there is still room to catch up to the long-term outperformance rate, especially for small-cap stocks.

We expect FII flows into mid/small-caps to remain strong as well for a few more months at least, with the potential for further increase. Given that the valuations are not cheap, we expect all the incremental flows to look for names that are cheaper on a growth-adjusted basis.

Vinit Bolinjkar, Head of Research, Ventura Securities

Mid/small-cap stocks are typically seen as having more growth potential than large-cap stocks. This is because they are often newer and more innovative companies that are still expanding their businesses. The Indian economy is growing at a healthy pace. This is providing a positive backdrop for mid/small cap stocks, as these companies are often more closely linked to the domestic economy. We would advise investors to continue their current SIPs in mid/small cap stocks, as this will help them to average out the cost of their investments and ride out any short-term volatility.

Narendra Solanki, Head Fundamental Research - Investment Services, Anand Rathi Shares and Stock Brokers

Earlier in the year at initial stages, the valuation gap was wider for midcaps in comparison to its larger peers and earnings also showed some improvement which led to outperformance. However, post-current rally the valuation gap has also almost closed, and earnings growth is also priced in. We believe investors should take caution in midcap space and see large cap better placed.

Vinod Nair, Head of Research at Geojit Financial Services

The upside is on the back of a rise in inflows from all corners, including FIIs, DIIS, and retail investors. Following the impressive resurgence of retail investors from April 2023 onwards, mid- and small-cap stocks are experiencing a sustained upward trajectory. This momentum is expected to endure in the near term, especially in the case of smallcaps, given their modest valuations and upside surprises on earnings growth due to stable demand and downside on input costs. However, mid-cap stocks are becoming expensive, leading to an anticipation of moderation in the rally in 2023 going forward.

Suman Bannerjee, CIO, Hedonova, a US-based hedge fund

I think mid and small-cap stocks have continued to rise despite market caution because many of them are perceived as undervalued, attracting investors looking for growth potential. Early entry into these stocks often results in better returns as they expand and gain market share. Only a few of the small-cap/mid-cap stocks have the ability to give multi-bagger returns. However, investors should remain cautious, and diversify their portfolios by investing in both small-cap as well as large-cap stocks.

Technical Outlook

Gaurav Bissa, VP, InCred Equities

Nifty mid-cap and small-cap indices have witnessed a breakout after a consolidation of over 18 months. The prices have moved up sharply post the breakout area. Currently, they are trading in overbought zones in the rsi studies. Investors are advised to use decline to add positions. However, stocks which have seen reversal or breakouts on monthly charts can be bought at the current juncture. Risk management becomes even more important in the current scenario.

Neeraj Chadawar, Head - Quantitative Equity research, Axis Securities

In March 2023, 33 percent of the stocks traded above the 200-day moving average, indicating that the market was in the oversold zone. The market has since recovered significantly, with 84% of the stocks now trading above the 200-day moving average, indicating it is near the overbought zone. From here, the market is likely to see a style and sector rotation. With the strong catch-up by midcaps and smallcaps in the last couple of months, the margin of safety at current levels has reduced compared to largecaps. Keeping this in mind, the broader market may see some time correction in the near term, while flows will likely shift to large-caps

Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of MintGenie. We advise investors to check with certified experts before taking any investment decisions.