Mid and small-caps have been catching investors' attention for the last couple of months.
Since July this year, the mid and small-cap indices have been outperforming the benchmark Sensex; the BSE Sensex has jumped 13% while the BSE Midcap and Smallcap indices have jumped 21% each since July.
On a yearly basis, however, the Smallcap index (up 1.54%) is behind the Sensex (up 2.88%); the Midcap index is up 5.35% year to date (YTD).
Why this outperformance?
The economic growth of the country is the major reason why the domestic market is showing resilience and the mid and small-caps are reaping the benefits of it.
Government reforms and initiatives along with easing commodity prices are expected to augur well for the domestic economy.
High-frequency data such as GST collections, vehicle sales and PMI data are showing an encouraging trend.
India has also emerged as a bright spot due to the slowdown in China and prospects of a recession in the US, UK and in Europe due to aggressive rate hikes.
"Global concerns such as a slowdown in China due to Covid restrictions and energy crisis in Europe act as a blessing in disguise for India. Due to China's slowdown, commodity prices have started to decline which augurs well for India as it is a net importer of commodities. Moreover, foreign entities are also looking at India as alternative sourcing of their raw materials which will result in a pick up in manufacturing activities. Overall, India is in a better place than other emerging countries in this tumultuous situation," Arijit Malakar, Head of Retail Research at Ashika Group pointed out.
A strong influx of retail investors also seems to have been an important factor behind the outperformance of mid and small-caps. Favourable macroeconomic conditions, along with other factors, have accelerated the rise of retail investors who bet on relatively cheaper mid and small-caps to get healthy returns.
"Domestic economic conditions such as healthy GDP growth, credit growth, double-digit corporate earning growth, robust tax collections, good monsoon, etc., have given a boost to retail investors. New investors continue to pour into the market at the rate of over five lakh new investors every week. This has supported the mid and small-caps," G. Chokkalingam, Founder & Head of Research, Equinomics Research & Advisory Private, explained.
Can the trend sustain?
Mid and small-cap may continue their outperformance for some time as a broad-based economic recovery will boost the mid and small-cap space.
"Mid and small-cap tend to outshine the large-cap peers when there is broad-based economic recovery as the former grow at a higher rate than large companies. It seems that the worst is behind us as inflation has started to peak out though in the US inflation is still at an elevated level. The domestic economy is expected to recover strongly in the next four-five years and that is going to support the mid-cap and small-cap quality companies," said Malakar.
Chokkalingam believes the outperformance of small and mid-caps may continue for a few more months due to the support from retail investors amid economic recovery.
Deepak Jasani, Head of Retail Research, HDFC Securities explained that growth in the economy and formalisation and shift from unorganised to organised will lead to better times for listed corporates – both large-caps and mid and small-caps which means that the mid and small-cap space will remain in limelight.
"This space will perform in turns vis-a-vis the large-caps with some times of outperformance and some of the underperformance depending on the risk appetite in the markets and flows from institutions vis-à-vis the local non-institutional flows," said Jasani.
Ashish Chaturmohta, Director and Head- Advisory Research, JM Financial Services pointed out that during volatile times, priority is always towards growth stocks and mid-caps and small-caps showcase the highest growth, hence, buying is more aggressive.
"We believe India to be the next manufacturing hub and play an important part of the global supply chain, hence, there would be various small and mid-caps that are future mid and large-caps. Therefore, we believe the trend is here to stay," said Chaturmohta.
Vinod Nair, Head of Research at Geojit Financial Services observed that since July, mid and small-caps have been outperforming due to the arrival of FII and domestic investors, which was dull during the year due to the world equity market.
"The mid and small-caps should catch up here forth after the setback," said Nair.
"This outperformance is expected to continue in the short to medium term as they are trading at a reasonable valuation compared to large caps and are trading at a discount to their historical valuation trend. However, it is safer to stick with quality as the economic risk in the world is still elevated, led by high core inflation and rising interest rates cycle," Nair added.
Nair said investors should not venture into overexposure in small-caps and be selective on stocks and sectors which are based on domestic growth like FMCG, green initiatives, consumption, banks, capital goods and manufacturing.
He said that an accumulation strategy for IT and pharma can also be done on a long-term basis through volatility is expected in the short–term due to recession.
Disclaimer: The views and recommendations given in this article are those of individual analysts and broking firms. These do not represent the views of MintGenie.