As a customary trend, mid-cap stocks in India typically trade at a premium compared to large-cap stocks, driven by their perceived growth potential and sustained demand from domestic investors. Over the past decade, basket of the top 100 mid-cap stocks has consistently commanded an average premium of 17% over the top 50 large-cap stocks. The lowest discount level was recorded at -9% during the pandemic-induced economic slowdown. This month, the premium peaked at 38%, currently settling at sub-30%, 1.65 times 10yrs average.
The buoyance of the broad market continues to be robust in CY24. Sustaining this trend relies on the ongoing ecstasy surrounding mid and small-cap stocks. However, maintaining this enthusiasm presents challenges being trading at high premium valuations. Consequently, a shift towards investing in large-cap stocks and pursuing value-based opportunities on a stock-to-stock basis seems logical. Retail investors may find it necessary to reduce their exposure to mid-cap stocks in their portfolios.
The volatility of the Indian stock market has noticeably escalated YTD. The India VIX index surged to a peak of 16.7x in February, up from 12.5x three months prior, and currently stands at ~15.5x. The increase is a combination of both global and domestic factors. Globally, speculation surrounds the timing and scale of the US Fed's first post-pandemic interest rate cut is leading to FIIs selling in emerging markets. And a slowdown in the world economy and a real estate problem in China are impacting the Asian market’s sentiment. Domestically, factors include an eventful year of election and final budget, the RBI’s tight policy, anticipating a slowdown in earnings growth in FY25, and a high level of margin funding contributing to heightened market fluctuations.
Despite encountering various challenges, the market has managed to surpass them and is now trading at a new high. While there has been a widespread recovery, primarily driven by robust GDP growth, market participants are exercising caution and showing a preference for high-quality large-cap stocks due to the current valuation gap. In the last 5yrs Midcaps have outperformed the large cap by 45%, providing a CAGR of 24% compared to 15% of the main index. Mid & small caps have outperformed in the last 3months, but the degree of outperformance has reduced, and on a one-month basis, they are marginally underperforming. We prefer large caps as a medium-term investment pattern.
In the current short-term scenario, it is expected that volatility will rise as the upcoming major event of the election draws closer. The ongoing robust pre-election rally, which is forecast to continue until the day of the election results, can take a breather in between. We can also expect a post-election rally if the results are in line with or better than forecast. Corporate Q3 results are healthy and in-line with expectations, nevertheless indicating a slowdown in earnings growth on a QoQ basis. This is expected to extend in FY25, leading to a slowdown in corporate profits compared to FY23–24.
These factors will be pivotal in shaping short-term movements within the domestic market, especially considering the lofty valuations. India has been holding the premium valuation for more than 3yrs, currently trading at plus 20x one year forward P/E. Furthermore, the gap between midcap premium valuations and large caps has once again breached record highs. But in contrast, it's still advisable to remain invested to fully benefit from the evolving Indian stock market. However, it is prudent to anticipate moderate returns in the short term and focus on upholding a diversified portfolio.
The author, Vinod Nair is Head of Research, Geojit Financial Services
Disclaimer: The views and recommendations above are those of individual analysts, experts and broking companies, not of Mint. We advise investors to check with certified experts before making any investment decisions.
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