MUMBAI : Small and mid-cap shares rose on Wednesday as investors snapped up beaten-down stocks, broadening the current market rally that has seen benchmark indexes climb to record highs in November.

Smaller stocks outperformed the benchmark indices, although the broader markets continued their climb, closing at record highs.

The BSE Midcap index advanced nearly 1% on Wednesday, compared to the 0.49% gain in the benchmark BSE Sensex. Year to date, the BSE Midcap index has declined 3.39% and the BSE Smallcap has plunged 8.63%, while the Sensex has gained more than 13%.

Investors are turning to smaller stocks as they offer a better risk-reward, with valuation discount of mid-caps versus large caps at close to a 10-year high, according to analysts at Citi Research. Investors also appear to be betting on a rebound in the economy, although macroeconomic data suggests otherwise.

With factory output in the September quarter contracting 0.4%, economic growth is likely to slow down further to less than 5% in the quarter, data for which is to be released on Friday.

Sensex vs mid-caps
Sensex vs mid-caps

“The markets are cheerful, hoping that the government will consider a new scrappage policy. Rate-sensitive stocks such as banks did well on expectations of a rate cut in the RBI monetary policy. Investors are expecting more measures from the government to support growth," said Vinod Nair, head of research at Geojit Financial Services.

The valuation discount seen in mid-caps highlights the improved risk-reward and low expectations, according to analysts at Citi. “Interestingly, this compares to highest premium to large caps in 2017—so in two years, mid-cap sentiment seems to have gone from extreme optimism to huge pessimism," the analysts said in a note on 25 November.

One of the reasons to buy mid/small caps is the high return potential, they said. “We have looked at the last 10 years’ performance to see what the odds are and no surprises, it remains tough to call those multibaggers—only 2% of small caps become large caps, while 20% no longer exist," said the analysts.

Meanwhile, foreign brokerages such as BNP Paribas are overweight on India. “We note that our December 2019 Sensex target of 40,500 does not suggest any headline index upside with index valuations above historical levels. About 17-18 Nifty stocks trade at a premium to their historical 5-year averages on a one-year forward price-to-book and price to earnings ratio versus 10-14 stocks about two months ago. Thus, the stock rally has broadened with the BSE Midcap index valuation back to near its historical average," BNP Paribas said in a note on 25 November.

Despite several positive policy announcements recently, including attempts to solve the problem of unfinished real estate projects and plans to simplify the GST, any recovery is likely to be slow, according to BNP Paribas.

“Thus, we think more consensus GDP growth estimate cuts could be on their way... Our assessment of over 35 high frequency indicators suggests that the slowdown is likely to persist for longer, but we believe further deep declines could be halted. Companies in the consumer-facing industries continue to highlight a potential further slowdown in the near term, but remain optimistic of an improvement in second half of FY20," said BNP Paribas.