Large-cap stocks back in the lead; Sensex up 3.7% this month

Sensex is up 3.7% this month, while mid-, small-cap indices are down 1.4% and 2.7%, respectively

The pandemic period has been greatly profitable for domestic retail investors who put money in small- and mid-cap stocks. The BSE Midcap has more than doubled since the end of March last year, while the BSE Smallcap is up nearly 3X during the period. The BSE Sensex that tracks the market capitalisation of the country’s top 30 stocks, on the other hand, is up only 85 per cent during the period.

The latest price change in the market, however, suggests that large-cap stocks are now making a comeback. while mid- and small-cap stocks are on the back foot for the first time in the period.

The Sensex was up 0.3 per cent on Tuesday, even as the BSE Midcap index was down 0.8 per cent during the day. The small-cap stocks performed even worse and closed with losses of 2.1 per cent for the day. With this Sensex is up 3.7 per cent, so far, this month, while the mid- and small-cap indices are down 1.4 per cent and 2.7 per cent, respectively.

This is for the first time in the last 17 months that mid- and small-cap stocks have underperformed the benchmark index. For example, in July 2021, the Sensex was up just 0.2 per cent against 2.5 per cent and 6.2 per cent gains logged by the mid-cap and small-cap indices, respectively. In all, the Sensex was up 10 per cent in January-July 2021, against a 29 per cent rally in the BSE Midcap and a 48 per cent jump in the BSE Smallcap.

Many analysts are calling it a reversal in investors’ sentiment in favour of large-cap stocks, away from mid- and small-caps. “This was waiting to happen, given the record performance gap between them and the benchmark index. Over the past year, small-cap stocks delivered 50 per cent higher returns than the Sensex. This never happened in the past,” says G Chokkalingam founder & MD Equinomics Research & Advisory Services.

He expects mid- and small-caps to underperform or even decline over the next few weeks, restoring the relative balance in the broader market.

Others see it through the prism of valuation. “Historically, mid- and small-cap stocks trade at a 30-40 per cent discount to Sensex stocks on valuation parameters like price-to-book value. The valuation premium had almost vanished by the end of July, thanks to the rally. This is not sustainable given greater financial risks that small companies carry,” says Dhananjay Sinha, MD and chief strategist JM Financial Institutional Equity.

He expects a repeat of 2018 when mid- and small-caps stocks saw a big correction in stock prices, even though the Sensex and the Nifty50 continued to make steady progress.

Others also see the impact of the IPO boom. “The rally in mid- and small-cap stocks is largely fuelled by domestic retail investors. This unexpected boom in the IPO market is, however, forcing many retail investors to sell in the secondary market to raise money for investing in IPOs,” says Shailendra Kumar, CIO Narnolia Securities. This, according to him, has put pressure on smaller stocks.

Analysts also say that there is no perceptible difference in the performance of large-cap stocks vis-à-vis mid- and small-caps stocks over the longer term, and their short-term performance follows a cycle.

Over the past five years, the BSE Sensex is up 91 per cent from around 28,000 in August 2016 to around 54,500, currently. In the same period, the mid-cap index is up 75 per cent while the small-cap index is up 112 per cent. So, large-cap stocks have done better than mid-caps in the past five years; the Sensex was ahead of the small-cap index until April this year on the base of August 2016.

The three market segments move in a cycle and the next cycle can belong to large-cap stocks, according to analysts.