While equity benchmarks the Sensex and the Nifty look set to end the year in the green, smallcaps are headed for a negative close in 2022.
The market has been on a volatile track in 2022 due to soaring inflation which triggered sustained rate hikes which, in turn, have raised fears of a recession in the US and Europe. Moreover, geopolitical tensions, rich valuations and worries over domestic economic growth, too, have weighed on sentiment.
Amid all this, equity benchmarks the Sensex and the Nifty hit their record highs of 63,583.07 and 18,887.60, respectively, on December 1.
Data show while Sensex, Nifty and Nifty Midcap 100 indices have risen in sync this year, smallcaps have underperformed strongly.
The Sensex and the Nifty both have logged a gain of 6 percent in 2022 as of December 19. The Nifty Midcap 100 index is also 6 percent up, but the Nifty Smallcap 100 index is down nearly 11 percent this year.
Economic uncertainty hits smallcaps
During economic uncertainty, largecaps tend to do better than the mid and smallcaps as their strong balance sheet and wider market share in their segments make them less vulnerable to macroeconomic headwinds.
Smallcaps suffer more and are more volatile than large and midcaps because they are neither market leaders nor have the strong balance sheet to endure the pain during market downturns. Investing in smallcaps is riskier, so investors avoid them when the economic outlook is hazy.
"Mid and smallcaps fare poorly when there is global uncertainty as investors prefer largecaps because they feel safer there. Benchmark index outperformed mid and smallcap indices due to higher valuation at the beginning of the year," said Akhilesh Jat, Category Manager - Equity Research, CapitalVia Global Research.
"Mid and smallcap companies saw a sharp drop in their margins. Sideway movement in these sectors will drag the valuation down which can attract investors," said Jat.
Should you bet on smallcaps?
The underperformance of smallcaps has given them valuation comfort but should that be the reason to start betting on them?
Smallcaps tend to do better in a bull market with a healthy macroeconomic situation. The Indian economy is expected to witness healthy growth in 2023 and due to its domestic-centric nature, it is expected to face less pain of a recession in the West.
However, headwinds prevail and they are not likely to fade anytime soon.
Brokerage firm Kotak Securities believes the market may continue to see consolidation over the next few months as it is yet to fully digest the headwinds of rich valuations, a longer phase of higher interest rates and concerns over growth.
Kotak expects CPI inflation to stay above 5 percent for most of FY24 and core inflation to be closer to 6 percent, which may preclude any quick pivot by the RBI.
Moreover, the brokerage firm expects the RBI to hold the peak policy rate at 6.25-6.5 percent for most of 2023 as it gauges the impact of monetary tightening on inflation.
The current market and economic environment do not look suitable for smallcaps. However, this does not mean that one should altogether avoid this segment.
In fact, there are many smallcap stocks that clocked healthy gains in 2022.
"Smallcap has been an underperformer in 2022 but selective smallcaps have done well where valuations were cheap or there was visibility in earnings. We have seen value buying in some smallcaps where risk reward was good," said Abhishek Jain, the head of research at Arihant Capital.
Analysts advise investors should pick quality mid and smallcaps with lower debt, reasonable valuation and high return on equity (RoE).
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.