Is it time to buy smallcap and midcap stocks?

Aditya Iyer and Raja Venkatraman

After nearly 15 months we are seeing some momentum return in small and mid-cap stocks. The reason for the sustained underperformance was due to the fact that we only saw PE expansion in small and mid-cap.

We analysed last two years data of top 100 companies to see what exactly was driving the outperformance. We found out that there has been very little change in EPS for most companies but there has been a drastic change in the PEs of these companies. Now the EPS, which is the actual earnings, was flat across and hasn't seen any improvement.

The fear trade seems to have topped out

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Fear has taken over and people have taken their investments and started running into certain large caps that worked. The Nifty rose 3% since Dec 17 but the performance top 15 Nifty stocks which amount to 65% of market cap was up 16% while the other 35 stocks were down by 16%. So clearly, investors have only been chasing those select mega caps defensive plays all through and have ignored smaller companies.

Source: MOSL

Historical data suggests the fall should be abated

The average length of any bear market in history is 15 months; we were already in the 15th month. Exactly one year back midcaps were valued 46% higher compared to large caps, now they are only 10% higher. Generally the spread between midcap and large cap returns was 15-20%. Now it has peaked 22 per cent, suggesting that midcap's underperformance vis-à-vis large caps might be coming to an end. One should also note that 79 out of 100 companies in the Nifty midcap index are still in the red. And I'll tell you one more thing, in last 13 years, that midcap index has never underperformed the large cap index for more than a year. It last happened in 2013 and we all know what followed and how the market rallied, right now we are in a very similar situation and the elections are nearby as well.

Technical View 

Source:  "Neotrader" by Chartadvise

Small cap index has been on a decline since 2018 after a sharp and buoyant 2017. In the process there was a 30% erosion in its value leading to a damage in sentiment amongst the retail participants. However, with a positive Budget that was proposed by the Finance Minister, there has been a turnaround. The emergence of some renewed FPI inflows coupled with a pre-election rally that is getting set the indices are suggesting some low value buying emerging in select mid and small caps. From the charts, we are able to witness a strong rebound on the weekly timeframe and it is clearly suggesting testing of the resistance zones. A confluence of the descending trendline as well as the value region around 14500 may attempt to curtail the exuberance. The momentum indicator is displaying more spirit this time around and the rise above 14800 could carry the trends to the upside as the buying interest would carry the index forward.

Along with the small cap the mid cap too has displayed renewed enthusiasm helping the broader indices move ahead. The midcap indices too had been on a decline and unlike small cap displayed bouts of optimism since its January 2018 high. However, unlike last time the revival seems to be holding on and we could look for some upward traction in this index. For some upside the trendline breakout is necessary and this could help in generating some strong upward traction.

Way forward

Summarising the setup on both the indices we can conclude that the retail participation is very much getting initiated and this would be a good time to start investing.

Things are improving on the ground, FII money is slowing and steadily finding its way back, the uncertainty discount that the market had applied on elections is slowing eroding, valuations are attractive and we are finally seeing the market coming back to life.  This is definitely a good time to be in the market and the best time to invest into our PMS – Plus Delta Portfolios from 3-5 year perspective as the base is very favourable.

(Aditya Iyer is Fund Manager, Plus Delta Portfolio; Raja Venkatraman is Head of Training, Chart Advise)

For more such articles, subscribe here. First Published on Mar 11, 2019 05:29 pm