Mid and Small cap stocks usually have lower liquidity making re-accumulation of these stocks a time consuming task and so the recovery in the fortune of aggregate mid and small cap stocks would not be V-shaped rather it would be U shaped.
The Sensex made a new life time high last week whereas BSE Midcap Index is down 16 percent from its year high. BSE Small Cap Index is down 20 percent from its 2018 January high.
This poor breadth of the market implies two things: Either Sensex is going to hit a significant high shortly and will correct over remaining months of this calendar year or now mid and small cap stocks will start rallying once again.
Market liquidity is usually very high for largecap stocks and so the recovery in a largecap stock can be fast or say V-shaped. Sensex too fell by 11 percent from January to March this year and from there it has recovered and has already hit a new high implying a real V-shaped recovery.
Mid and Small cap stocks usually have lower liquidity making re-accumulation of these stocks a time consuming task and so the recovery in the fortune of aggregate mid and small cap stocks would not be V-shaped rather it would be U shaped. So, the rally only after a long consolidation.
In terms of valuation, mid and small indices still trade at a higher multiple than average long term premium over large cap peers.
Another 5-7 percent of underperformance will bring Small cap valuation closer to historic average and then it would be safe to start accumulating those stocks in steps keeping in mind that re-accumulation of those stocks would be time consuming to make that a U shaped recovery.
Mid and smaller companies are exciting stories in Indian equity investment space particularly in the context of formalisation of the economy. The sharp rally in small and mid cap space in 2017 had happened on account of future benefits from GST implementation. Though large amount of money chasing these smaller companies made their valuation unsustainable high and has resulted in this correction.
A large cap company is already operating in a formal environment. Whereas smaller listed formalised company operates in direct competition to the unorganised players of the economy.
Once GST and E-way bill stabilises operationally and the focus shifts to compliance, these smaller listed formalised companies will have way more advantage over their unorganised peers.
These positive changes in the economy would be visible in the earnings of smaller companies from FY2020 onward. And that revival in earning would be the trigger for next wave of broad based rally.Disclaimer: The author is Chief Investment Officer, Narnolia Financial Advisors. The views and investment tips expressed by investment expert on moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.