Broadly strong corporate earnings, efforts by the government and central bank to bolster the economy, and a surge in retail trading have helped smaller shares start to outperform since summer. And while the Nifty’s price-to-earnings multiple has reached an all-time high, the small- and mid-cap gauges are trading at similar valuations to late 2017, the last year they outperformed the larger index.
“Such turn in performance does not fizzle out so fast, especially when the valuation gap is still there," said Vinod Karki, head of strategy at ICICI Securities Ltd., the nation’s largest listed broker. “High liquidity and prospects of economic recovery are perfect recipes for relatively riskier assets such as smaller-sized companies."
The measures of small- and mid-cap stocks fell over the last two years as concerns over slowing economic growth drove investors to the safety of their larger peers. Covid-19 initially fanned such concerns, casting doubt on the ability of smaller companies to withstand a nationwide lockdown that drove most business activity to a standstill.
Now there are hopes for a rebound. India’s gross domestic product shrank a less-than-expected 7.5% in the three months ended September, a marked improvement from the June quarter’s record 24% contraction. The outlook for earnings has improved as a slew of indicators suggest a gradual recovery in activity across the key services and manufacturing sectors, as well as a gradual revival in consumption.
“We believe that the lead current indicators on earnings and sentiment are supportive of a significantly new high over the next 18 to 24 months for the mid-cap and small-cap indexes," said Amit Khurana, head of equities for Dolat Capital Market Pvt Ltd. “Going forward, economic recovery, expectations of sustained customer demand and liquidity will drive gains."