Euphoria of mid and small caps will consolidate going ahead, says market expert

From 31st March 2023 to 29th February 2024, the domestic stock market has delivered a robust return. This was led by backlash reaction of a consolidation during Jan to March 2023, led by FIIs and Retail selling. With valuations contracting, the domestic market became more appealing. The upward momentum was further boosted by upgradation of GDP forecasts for FY23 and FY24, rising to 7% from the previous 6% forecast. 

Corporate earnings growth was exceptional. For example, in H1FY24 (April – Sept 2023), the Nifty50 and Nifty100 constituent stock baskets witnessed impressive PAT growth rates of 27% and 35%, respectively. Primarily, there was a resurgence in domestic inflows, particularly benefiting mid and small-cap segments. 

Given the robust return, it's prudent for short-term investors to consider securing some gains home. March, being a period for tax calculations, prompts investors to be mindful of their tax obligations. Profit booking and generating some cash in hand for future tax bills are some of the plans on the table. Nonetheless, this isn't a major concern, as historical data indicates March has typically been a positive month, yielding an average return of 2.7% for the broad market over the last decade. Q4 is the best business period for India and boost AUM. 

Given the heightened last one-year performance and elevated valuations, coupled with the transient state of both global and domestic economies, it is essential for investors to contemplate a review and reshuffling of their portfolios. It is likely expected that the euphoria of mid and small caps will consolidate ahead. In contrast, a strategy focusing on large-caps and individual stock selection is deemed more reliable for short to medium-term. 

The premium valuation of Midcaps has started to consolidate after reaching to record levels of 40% to 26% today. Corrections in these segments are underway and expected to persist, with regulatory bodies urging AMC to review and disclose the risks associated with the high-risk category. Some mutual funds have halted new inflows into mid and small-cap schemes due to a lack of fresh opportunities in this area. Currently, the one-year forward P/E ratios of midcaps and small caps stand at 26x and 21x, 12% and 24%, respectively, above their 5-year averages.

Mid & Smallcaps are underperforming…

It is prominent to acknowledge that a good amount of the mid & small caps rally in FY24 was triggered by high inflows from retail investors. Led by both, inflows through MFs and direct investment. SIP inflows were ₹18,800cr for January 2024, up 36% YoY. From a 4 cr. demat in March 2020, we have come to 14 cr in 2024.  On a YoY basis, the demat account has increased by 30% from 11cr in Jan 2023 to 14.4cr in Jan 2024. 

This month’s volatility does emerge being a heavy economic data release in India and globally. Despite these challenges, the main indices have managed to perform well, largely driven by strong India GDP figures of 8.1% YoY for Q3. Moreover, the RBI's initiative to increase liquidity in the banking system, transitioning from deficit to surplus, has instilled confidence in the banking sector and prevented any significant downturn in the broader market.

Global markets have been flattish in the last one month, with a negative bias, speculating the future course of Fed action on rate cuts. It's widely anticipated that the Fed chair might downplay the necessity for immediate rate hikes, favouring a gradual approach later in the year, contrary to the market's more rapid expectations.  However, the cut trajectory is likely to be accommodative in the second half based on recent FOMC minutes, suggesting the policy rate may have peaked and higher rates could hinder growth. Hence the downside risk of global market looks limited.

The author, Vinod Nair is the Head of Research, Geojit Financial Services.

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