Midcap meltdown: Should investors look at largecaps now?

Nifty Midcap index breached below the 39,000 mark for first time since August 2023

'Largecap ka time aa gaya' wrote several investors on micro-blogging site X as they shared screenshots of 4-5-6 percent fall in their portfolios, weighed down by midcaps and smallcaps on October 23. Amid weak global cues as risk-off sentiment rises, hopes of largecaps outperforming midcaps at least over the next six months are also growing.

At close, the Nifty Midcap 100 index was at 38,817.35, nearly 2.66 percent down from close on October 20. The index breached below the 39,000 mark for the first time since August 2023. Meanwhile, Nifty 50 saw a smaller fall of 1.3 percent to close at 19,281.75.

Globally, macro risks have been building up over the past few weeks and markets were bound to become narrow, believes Amit Jeswani of Stallion Asset Management. "Fund managers can’t go out and say ‘All is well’ when US 10-year (risk-free rate) is above 5 percent. In this risk-off sentiment, broader markets will see a sharper correction than largecaps."

Midcaps have outperformed largecaps so far, ever since the market upmove started in March. Nifty 50 is up 13 percent while Nifty Midcap 100 is up over 32 percent. During this time, valuations in the midcap space have become extremely frothy. In March, Nifty Midcap's price-to-earnings ratio was at a 6 percent premium to Nifty 50's. Now, it is at 12 percent premium.

Thus, several fund managers have chosen to sit on cash or make reallocations towards largecaps.

Case in point, Prashant Jain. When he started his fund 3P India Equity Fund earlier this year, he had a mix of small- and midcap stocks. But now, the majority of his portfolio is in largecap stocks like HDFC Bank, ICICI Bank, Mahindra & Mahindra, Maruti Suzuki and L&T.

"Small- and mid-cap stocks have performed exceptionally well in recent times, making it increasingly challenging to find reasonably valued stocks with realistic growth expectations. We are now directing almost all our investments toward the largecaps," Jain said in a recent interview with Moneycontrol.

Also Read: Large-caps offer value, current valuations attractive: Prashant Jain of 3P Investment

Nifty 50 valuation support

If we look at Nifty level back in October 2021, it was close to 18,200. On October 23, it closed at 19,280, which indicates a mere 6 percent return in the last two years. At the same time, Nifty EPS in FY22 ended at Rs 765 versus Rs 950 estimate for FY24.

"So Nifty EPS has appreciated by 24.5 percent whereas the market is delivering a return of 6 percent. I believe there is a lot of scope of price catching the earnings," Rajesh Kumar Jain, Head of Private Client Business, Anand Rathi Group said.

"Most of the largecaps are trading below their mean average multiple Hence at these times of crisis, investors will move from high beta names to defensives and largecap is the place most of the investment will take its shelter where valuation supports," he added.

Also Read: Midcap underperformance may continue, say analysts

In a report dated October 9, Kotak Institutional Equities noted that five out of the top-six stocks with a weight of 34 percent in the Nifty 50 index have delivered negative returns over the past two years. Twenty-two stocks with a weight of 55 percent in the Nifty 50 index have given less than 10 percent returns over the past two years.

In this context, KIE's Sanjeev Prasad said that his team finds much better value in the top largecap stocks, most of the top 15-20 stocks by market capitalisation, and expect them to outperform in the next 6-12 months.

"We do not find much value in most of our midcap and smallcap coverage universe (150 stocks). The better-quality stocks may see time correction, while plenty of lower quality mid- and smallcap stocks could see large price or lengthy period of time correction," Prasad said.

Opportune time for bottom picking?

Meanwhile, some fund managers believe that the next six months also make it a ripe time for bottom-picking stocks in the midcap space as it undergoes a correction.

Also Read: Smallcap stocks for long-term growth that category III AIFs like

"Largecaps may outperform given the valuation difference and stable earnings growth profile. But, correction also provides us an optimal time to pick stocks to add to our portfolio," said Chandraprakash Padiyar, senior fund manager (equities), Tata Asset Management Company. He believes the manufacturing sector has some stocks where ‘growth is coming at a reasonable price’.

Similarly, Jeswani says that sentiment can only drive markets by 10 percent. "Beyond that, it is earnings and valuations which matter the most," he said. As per Bloomberg, Nifty Midcap 100 EPS is expected to grow in 20s over the next two years while Nifty 5o EPS is set to grow in teens. For midcap, the investment horizon always has to be over 3-5 years, they said.