Broader market rebounds with BSE smallcap, midcap indices up 1-2%

Kotak Institutional Equities believes that most mid- and small-cap. stocks are still trading at full-to-lofty valuations despite the sharp correction in recent weeks.

The broader market staged a strong comeback with a 1-2 percent rise in BSE SmallCap and MidCap indices on March 14.

The indices suffered the blaze of intense selling in the previous session which, analysts believe, was a result of a strong rush to book profits on the back of sustained exuberance in the segment.

On March 15, mutual funds are expected to disclose their stress test reports regarding the capacity of small- and mid-cap fund schemes to handle abrupt redemptions because of unfavourable market conditions.

Discussions surrounding liquidity challenges in small-cap funds and the increasing excitement in this segment have raised the concern for months. Market regulator Securities and Exchange Board of India (Sebi) has been actively engaged with mutual funds to find an appropriate solution to this issue.

Sebi has also been pushing towards limiting the risks in the small and mid-cap indices that has resulted in the tightening of norms around mutual fund investments. This has weighed on the mid and small-cap segments in recent times and, in turn, triggered bouts of strong profit-booking.

The positive sentiment around several pockets within the broader market has attracted investors to lap up stocks in times of declines. Value buying within the segment has lifted the smallcap and midcap indices higher. At 10.30am, the BSE Smallcap index was up around 2 percent while the BSE Midcap gained 1 percent.

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Kotak Institutional Equities believes that most mid- and small-cap stocks are still trading at full-to-lofty valuations and well above their fundamental value despite the sharp correction in recent weeks. "We are not sure if the correction marks a reversal of the market to fundamentals and numbers from sentiment and narratives. If it is the former, many low-quality stocks may still have a long way to fall, in our view," the firm stated in a note.

However, the firm is not sure if there will be any change in the investment behaviour and optimistic view of non-institutional investors as a result of the recent correction and cautionary statements of the regulator.

"In our view, high return expectations and high returns over the past three years may have reinforced their direct participation through mid- and small-cap. stocks and indirect participation through mid- and small-cap," Kotak added.

Meanwhile, Mirae Asset Mutual Fund stated in a note that the broader market has outperformed Nifty 50 by 30-50 percent in last one year, largely due to strong flows in funds focused on mid/small caps, adding that flows could be at a cyclical high.

“On the other hand, large-cap stocks have seen outflows (flows are at a cyclical low). As a result, Mid/Small cap stocks are trading at a significant premium to large cap. Nifty 50 is at a reasonable valuation of ~20x on FY25 earnings with a good earnings growth outlook. In this context, currently, large cap-focused funds appear better placed,” the fund added.

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