We have been urging our investors to increase allocation towards midcaps. We believe there must be a balanced approach as both types of flows will enter the market I.e. retail and institutional flows.
India voted for a decisive mandate which was welcomed by the market with cheer. We saw a strong pre-election rally, and the strong mandate carried the Nifty50 to its all-time highs.
The market was hoping for a stable government and the continuity of policy. For equities, as an asset class, a stable government has always resulted in an increase in risk appetite amongst investors.
We saw that, in 2014, smallcap stocks went through the roof along with a broad base market movements. We expect a similar phenomenon to transpire, and we are already seeing a hint of the same.
Rally in Non Nifty stocks giving the first indication
A study on the volume action and price action of non-Nifty stocks are indicating that the market is willing to look beyond the select mega caps, and the risk profile of market participants might be changing.
Interestingly, in the past few days, the volume of midcaps as a percentage of total NSE volumes has risen sharply and is currently accounting for more than 50 percent (after dipping down to 37-38 percent recently).
Generally, when risk appetite is low, the Nifty50 stocks form a majority of volumes as evidence much through 2018 where they accounted for nearly 60 percent of NSE volumes.
However, when the risk on sentiment returns, this trend has reversed. For example, Nifty volumes to total NSE volumes kept declining from 46.9 percent in 2014 to 38.6 percent in 2017 when midcaps ruled the roost.
Hence, the market preference towards midcap is usually a feature of bullish sentiments and suggests a stance by investors towards riskier assets.
Also, sectors that have been beaten down for years have started heating up, For example, the Nifty Reality sector which has been down for 10 years has risen 22 percent since February-lows, and the Nifty PSU index has moved 31 percent from its February-lows.
Moreover, the number of stocks recovering from their recent lows has displayed its fastest ever rise above 20-DMA since January 2017. This is another signal of some aggression to buy and perhaps attests to a large amount of money waiting in the wings to be deployed into the market.
The market was dominated by a few stock. Now, we see the rally become broad-based. Hence, Gradual Mean reversion will ensure Midcap outperformance.
The mid and small cap universe has had a huge underperformance compared to large caps. In the midcap space, stocks are still trading up to 83 percent lower from their 52-week highs.
The valuation differential also is hitting historical highs. The Midcap forward PE, which is currently trading at a 19 percent discount to NIFTY forward PE, is moving towards historical extremes. Eventually, it will have to mean revert.
The midcap index to Nifty ratio is at 1.5, the last time we witnessed these levels was in 2005.
Similarly, the Smallcap index to Nifty ratio is at an abysmal 0.5
Both these ratios are well below the 15-year average and have moved into very extreme zones. Prices will not sustain at such extremes for long and will eventually have to mean revert. Once the mean reversion process begins, we will start witnessing a catch-up trade in these counters and that will create the bouts of momentum that can be grabbed.
Pace of equity inflows to increase
Equity inflows into the markets will definitely see a significant increase in the coming months. As I stated in my last article, FII flows will continue to increase, domestic institutions that were net sellers would also start going long.
Since the election uncertainty has ended and we have a clear road ahead, the pace of SIP and mutual fund flows into the market has increased.
As incremental bunched up domestic flows that were sitting on the side-lines will be unleashed in the market. The case in point would be the recent MSCI rejig which the market gobbled up in one day. Passive FPI outflows have been replaced by active FPI inflows and DII inflows.
Retain bias towards Midcaps, albeit with a balanced approach
Opportunities will arise in various pockets of the market. A decline in oil prices and rupee appreciation can benefit OMCs that gain from lower under-recoveries and manufacturing companies that get a fillip in the form of lower input cost inflation.
Through these letters, we have been urging our investors to increase allocation towards midcaps. We believe there must be a balanced approach as both types of flows will enter the market I.e. retail and institutional flows.
This will create momentum breakouts in many stocks that investors can use to profit from. Our property investment model is built to take advantage of these factors, and investors can reach out to Plus Delta portfolios to gain from these investment themes.
(The author is the Fund manager of Plus Delta Portfolios- PMS vertical of Growth Avenues)Subscribe hereSubscribe to Moneycontrol Pro and gain access to curated markets data, exclusive trading recommendations, independent equity analysis, actionable investment ideas, nuanced takes on macro, corporate and policy actions, practical insights from market gurus and much more.