Steep fall in Indian equities dashes the hopes of mid-, small-cap recovery

The steep fall in Indian equities on Monday has dashed the hopes of broad-based recovery in the market. The Nifty MidCap Index and the SmallCap Index have now come off nearly 20 per cent from their 2020 highs.

Many brokerages and fund houses were expecting a more broad-based rally this year, after acute polarisation in the markets over the past two years. Experts believed that valuations of mid- and small-caps had slid to reasonable levels, limiting further downside, and raising hopes of gains in quality names.

This optimism was reflecting in the stock price as the mid-cap and small-cap indices outperformed benchmark indices by a huge margin until mid-January.

“A substantial price correction since 2018, attractive valuation, and volume compression indicating bottoming out make small-caps a compelling category to invest in,” a note by IDFC Asset Management in January had observed. “For investing in small –caps, ‘timing’ and ‘time in the market’, both, are extremely important for generating superior returns. As a caveat, while the opportunity seems thought-provoking, one has to keep in mind the risks of its large drawdowns and a wide range of returns.”

The indices have slid 15 per cent and 14 per cent, respectively, since February 7, and are down about 10 per cent year to date.

 

 

Brokerages had pinned their hopes of a rally on a broader economic recovery, which may not pan out as expected in the aftermath of the spread of COVID-19.

According to Morgan Stanley, global growth is expected to dip to 2.3 per cent in the first half of 2020, as COVID-19 disrupts near-term economic activity.

“Until the coronavirus scare, the market consensus was of a 24 per cent growth in Nifty, but now these numbers will need some heavy-handed revisions,” said an investment strategy report by Sanctum Wealth Management.

Moody’s has revised its baseline growth projections for India to 5.3 per cent for 2020, from 5.4 per cent earlier. It has warned that a prolonged slump, owing to the coronavirus outbreak, could reduce growth to 5 per cent this calendar year.

“Historical data suggests that the performance of mid-cap companies in India is closely linked to economic growth, and mid-caps tend to deliver strong returns in periods of good economic growth, while underperforming large-caps during economic downturns,” said Jitendra Gohil, head, India equity research, Credit Suisse Wealth Management, in a January note. “In our view, it is paramount that GDP growth is broad-based. Otherwise, the rally in mid- and small-caps will not be sustained.”

The brokerage had also cautioned that while the correction in mid- and small-cap indices looked steep, the valuation was not cheap. 

“The headline index valuation is currently fair but not cheap, and investors should therefore be careful in picking mid-cap stocks. We prefer high-quality mid-cap companies with a very strong management and track record.”

According to an analysis by ICICI Securities, nearly half the Nifty50 companies’ net profit has exceeded consensus estimates. On the other hand, only about a third of the companies in the mid-cap and small-cap universe have managed to beat expectations. 

This is despite the cut in corporation tax rate by the government, and softness in raw material prices during the quarter. Most companies, irrespective of which universe they belong to, have missed their sales estimates, reflecting weakness in the economy.