Beware: Can midcap stocks see a repeat of the 2017 crash?

Well, for a young stock market enthusiast like me, I couldn't quite relate to this.

I mean, in the stock market or as a matter of fact anything in life, timing plays a key role.

Another thing which veterans told us which is a continuation of the above adage is.

'Time in the Market is more important than Timing the Market'.

Now I completely agree with this.

I did some data crunching on the whole idea of buying stocks at the peak vs buying stocks at the bottom and then calculating their long-term returns.

Let's take the example of two investors, A and Investor B.

Investor A started his Systematic Investment Plan (SIP) in Nifty at the bottom of 2008 crash.

This is when there was a flash sale and things were available at throw away prices.

After all, the narrative is that the global financial system had collapsed and will fireball in to Armageddon.

Investor B for whatever reasons best known to him, started his Systematic Investment Plan at the peak of the 2008 bubble (end of 2007).

This was when infrastructure and real estate companies were trading at a P/B multiple of 8-10 times.

In fact, the same infrastructure and real estate companies were available at their book values a couple of years ago.

Such was the hysteria before the crash.

Fast forward 10 years to 2018...

If you were to take a guess, I am sure the answer would be, investor A who started his SIP at lows would have outperformed investor B?

Well, the difference in Nifty returns of both investors was hardly 1%.

In the end, investing every month for a consistent period of 10 years humbles even the mistake of investing at the peak.

At the end of the day, stocks and indices always revert to mean.

However, there is a catch here...

The key word here was SIPs, i.e., religiously investing a fixed amount every month for a prolonged period.

So, does that mean, timing the market is fruitless?

I don't think so...

Let me give you another example.

Reliance Industries is a classic example of how timing the market/stock is the key.

Let's say individual A invested in Reliance Industries in 2009 and individual B entered the stock in 2017.

The contrast in returns is startling.

That is 8 years of massive underperformance.

It didn't matter whether you did an SIP or invested lumpsum, as the stock barely moved.

Now let's look at Reliance Industries performance from 2017-23.

So, does that mean it is pertinent to time the market?

My father always told me the following...

Theories and logic are created by investors. The market is not obliged to follow it.

At the end of the day, the price is always right and stock markets are supreme.

There is always a difference between buying Nifty as a basket and buying individual stocks.

Timing the market works when you are buying individual stocks especially companies in the small and mid-cap space.

The most important criteria for smallcaps and midcaps are valuations.

Buying stocks at much lower than median valuations is nothing but timing the market.

A lot of people misconstrue timing the market as giving Nifty or Sensex targets.

Timing doesn't mean predicting where the index will be one year or two years from now.

Trust me, even if I had a crystal gazing ball, I wouldn't have been able to do that.

The whole concept of timing the market, or in this case timing the stock, is to wait for valuations to moderate and then buy.

You could buy a stock at expensive valuations, but in that case, you need to be sure of the super normal growth ahead which will moderate valuations.

Or you could buy a stock at a valuation lower than its median valuations.

In my opinion, timing the market is equally important as time in the market.

That leads us to the current market scenario.

I am sure, the journey over the past 6 months especially in the mid and smallcap space has been exhilarating.

What a run it has been especially in railway and PSU stocks.

Anything remotely linked to railways has become a market obsession.

But the billion-dollar question is...

Are We Approaching Dangerous Territory?

Do we see a repeat of 2017 mid and smallcap crash? It was brutal, with individual stocks correcting 30-50% from the peak.

The answer to this is Yes and No.

We are approaching danger territory in some select small and midcap stocks. Though we haven't got there as yet.

The only comfort I have is earnings growth.

The only problem I have I valuation multiples way above their historical mean and expanding at a much faster pace than expected.

A worrying sign in the market is the SME IPOs which come out with an issue of few hundred crores but get bids 50 times higher.

SME stocks list at 100-150% premium and continue to go up.

Railway and defence stocks are more than doubling in 3-6 months. I agree they were cheap at that time but such a sharp run was unwarranted.

The sheer velocity of the run up in small and midcap indices without even little consolidation isn't healthy for the markets.

A Comforting Sign

Strong earnings growth is what I take comfort in.

Order books of manufacturing and infrastructure companies are close to all time highs.

My barber hasn't told me which mid and smallcap stocks to buy yet. The next time I go for a haircut and if he tells me, then the message of a bubble would become clear.

Disclaimer:This article is for information purposes only. It is not a stock recommendation and should not be treated as such.

This article is syndicated from Equitymaster.com