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Business News/ Markets / Stock Markets/  Midcaps, smallcaps strongly outperform Sensex in 2024 despite valuation concerns; what is driving broader market?
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Midcaps, smallcaps strongly outperform Sensex in 2024 despite valuation concerns; what is driving broader market?

Mid-and small-cap segments continue to outperform Sensex in 2024, driven by solid economic growth, retail investor rise, and capital inflow. Analysts warn of premium valuation concerns limiting upside potential.

Midcaps, smallcaps: Until the June 10 close, the BSE Sensex gained nearly 6 per cent, while the BSE Midcap index has surged over 20 per cent and the Smallcap index has risen over 15 per cent this year. (Agencies)Premium
Midcaps, smallcaps: Until the June 10 close, the BSE Sensex gained nearly 6 per cent, while the BSE Midcap index has surged over 20 per cent and the Smallcap index has risen over 15 per cent this year. (Agencies)

Midcaps, smallcaps: Amid the cacophony of unsustainable valuation and froth-building, the rise of mid-and small-cap segments remains unabated.

This year, the mid-and small-cap indices have significantly outperformed the benchmark Sensex, raising questions about why many analysts' predictions were incorrect.

Until the June 10 close, the BSE Sensex gained nearly 6 per cent in Calendar 2024. In comparison, the BSE Midcap index has surged over 20 per cent and the Smallcap index has risen over 15 per cent. These segments have witnessed a sharp rally after the return of the BJP-led NDA to power at the Centre.

Year-to-date return of Sensex, BSE Midcap and BSE Smallcap indices
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Year-to-date return of Sensex, BSE Midcap and BSE Smallcap indices (BSE/Mint)

On Tuesday, June 11, the BSE Midcap and Smallcap indices rose almost a per cent each to hit their fresh record highs of 44,670.10 and 49,671.72, respectively.

Why are mid- and smallcaps rising?

India's solid economic growth, the strong rise of retail investors, and the sustained inflow of capital into the broader market through the SIP route are some of the biggest reasons for the outperformance of midcaps and smallcaps.

"The explosive growth in the number of demat accounts from around 4crores in early 2020 to above 15 crores now have created a new breed of newbies who are chasing the mid and smallcaps," said VK Vijayakumar, Chief Investment Strategist, Geojit Financial Services.

Also Read: Foreign investment surge fuels spectacular rally in India’s smallcaps amid bubble alerts

"The sustained flow of mutual fund investments, particularly SIPs, into the broader market gives no option to the fund managers but to buy mid and smallcaps even when the valuations are high. The current pattern of fund flows and retail investor behaviour may sustain the outperformance of this segment for some more time. But investors should be vigilant. Undoubtedly, safety is in largecaps," said Vijayakumar.

Also Read: Equity mutual fund inflows skyrocket to record 34,697 crore in May, SIPs reach 20,904 crore: AMFI

Another important factor behind the outperformance of midcaps and smallcaps is robust corporate earnings growth.

Mythili Balakrishnan, Co-Fund Manager at Alchemy Capital Management, believes the underlying earnings of midcap and smallcap indices may grow at a compound annual growth rate (CAGR) exceeding 20 per cent over the fiscal year 2024 to 2026, surpassing the mid-teens growth seen in the Nifty 50. The higher valuations of the midcap and smallcap indices reflect this stronger underlying earnings trajectory.

Additionally, Balakrishnan underscored that sectors experiencing notable performance, such as real estate and defence, have a greater representation of small and midcap companies, contributing to the overall outperformance of midcaps and small caps.

"Given the continuation of the government and strength in the domestic economy, we remain positive on the space," said Balakrishnan.

Also Read: 5 top performing large and mid cap funds over 10 years

Another key factor driving the fresh wave of the rally is the hope for political stability and policy continuity.

"The recent upside in mid and smallcap stocks have been on the back of the prevalent positive sentiment in overall markets surrounding the return of Modi 3.0 regime. Markets seem to factor in the continuation of policy initiatives, with little impact on the decision-making due to the coalition government at the centre," said Manish Chowdhury, Head of Research, StoxBox.

Premium valuation remains a concern

Most analysts believe premium valuation of the midcap and smallcap segments is a concern which can limit their upside.

Amit Goel, the co-founder and chief global strategist at Pace 360, pointed out that the PE (price-to-earnings) ratio of the Nifty 100, representing large caps, stands at 23, with a PB (price-to-book) ratio of 4.3. In contrast, midcaps have a PE ratio of 40 and a PB ratio of 4.8, while small caps have a PE ratio of 29 and a PB ratio of 4.15, indicating they are relatively expensive.

"The market cap ratio of small caps to large caps has surpassed levels seen during the 2008 global financial crisis, indicating an overstretched rally in small caps," said Goel.

Also Read: Avoid investing in midcaps, smallcaps, advise experts after massive outperformance

Goel underscored that the Indian market's valuations are expensive relative to ordinary corporate earnings growth, with P/E ratios at all-time highs.

"Indian markets are extremely overvalued and overstretched. We don’t see this trend being sustained, as Indian equities represent the biggest bubble ever in the history of world equity markets. We recommend that investors stick to fundamentals and look for high-quality Indian stocks with a price-to-earnings ratio of less than 30 and reasonable valuations for short to medium-term buys," said Goel.

Chowdhury of StoxBox advises investors to avoid new positions in mid- and small-cap stocks, anticipating volatility in the short term.

"With volatility expected going ahead, we would advise investors to avoid fresh positions in the mid and small-cap space and judiciously keep booking profit on every rise. We anticipate stock-specific action, and a fresh entry is only advised on company-specific fundamentals and in pockets where valuation is still reasonable," said Chowdhury.

Read all market-related news here

Disclaimer: The views and recommendations above are those of individual analysts, experts, and brokerage firms, not Mint. We advise investors to consult certified experts before making any investment decisions.

 

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Published: 11 Jun 2024, 10:53 AM IST
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