With the Prime Minister Narendra Modi-led National Democratic Alliance (NDA) returning to power, some traders are hoping that the battered mid- and small-cap stocks, which hogged the limelight post-2014 elections, would make a comeback again. This optimism is stemming from expectations of the government’s renewed focus on reforms to boost growth.

While that could improve sentiments a tad for these stocks, it won’t be enough to stage a massive recovery. Even though a pro-reform government has returned to power, the country’s macroeconomic scenario has deteriorated. The government has limited means to fix the ongoing consumption slowdown. Besides, the US-China trade tussle continues to weigh on global economic growth.

“Mid-caps have been underperforming large-caps since 2018, but are still not at attractive levels, especially vis-à-vis the start of the previous cycle in 2013-14 when the valuations were at multi-year lows. Also, we think there is a structural difference in mid-caps as an asset class now, compared to 2013-14. Many quality mid-cap companies are already close to their peak valuation range. Thus, in the earlier cycle, these quality companies got meaningfully re-rated and led the rally, which is difficult this time," said Gautam Chhaochharia, head of India Research at UBS Securities India Pvt. Ltd.

“There is an economic slowdown across the globe. It’s going to be very difficult for India to buck this trend. Mid-caps or small-caps in general are smaller businesses and, on an average, are less strong than their large-cap counterparts. Investors need to be aware of this risk and not go blindly after the entire universe, expecting higher returns," said Samit Vartak, founding partner and chief investment officer of SageOne Investment Advisors Llp.

Considering the uncertainty on economic growth, it is very unlikely that corporate earnings growth will revive soon. Without the support from earnings, even if there is a rally in these counters, it won’t last long. “Lack of earnings momentum is the biggest risk to mid-cap stocks," said Chhaochharia of UBS.

Tushar Pradhan, chief investment officer at HSBC Global Asset Management (India) Pvt. Ltd, said,“It would be wishful thinking to expect mid- and small-caps to repeat their performance seen post 2014 polls. Valuations may seem to be fair, but they have to be backed by earnings growth."

Besides poor earnings growth, what makes one sceptical about mid- and small-caps is the liquidity crunch, which has impacted a number of sectors.

In terms of valuations, mid-cap stocks are still trading at a discount to large-caps. The Nifty Midcap 100 index is currently trading at a one-year forward price-to-earnings multiple of 15 times, lower than the 18 times of the Nifty 50 index. Also, so far in this calendar year, the mid-cap index has continued to underperform the large-cap one.

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