As of now, mid-cap index is in “correction” and the small cap is in “rally attempt” till it breaches its recent lows
We might be in 2018 but this is not the first time that small and mid-caps are in bad shape. If you remember, in February as well as in May earlier this year, these indices corrected by about 15-20 percent.
But, technically both indices got support and macro trends were favourable which led the recovery. This helped the small-cap and mid-cap stocks deliver strong returns in Q1FY19.
However, since September-end, both small & mid-cap indices are consistently breaching their recent lows and are in correction mode. Apart from the -20 percent thumb rule, a bear market makes it difficult for investors to make money and we are currently in such a market.
The Nifty Mid-cap and Small-cap have corrected 24 percent and 38 percent respectively from their highs of 21,840 and 9,656 respectively, which were observed during January. The Nifty50 has corrected by only 11 percent from its high of 11,760.
Nifty Mid-cap and Small-cap indices were in an uptrend till mid-July. And, following the trend, we moved their status to uptrend under pressure from mid-July till mid-September and subsequently to “correction” two weeks back (21-Sep).
As of now, mid-cap index is in “correction” and the small cap is in “rally attempt” till it breaches its recent lows. In the current scenario, correction is extended and prices have gone way below major support levels for most stocks.
In addition, a blend negative news about crude prices, currency, and liquidity in NBFC have added to the uncertainty.
We believe we are in the midst of a cyclical correction, which might continue till next year mega elections. Smaller stocks with weak fundamentals and extended valuations could fall the most.
Ideally, an investor should avoid bottom fishing as there are no clear signs of a reversal from the current levels and leaders from benchmark indices have also started correcting.
An ideal approach would be to wait and watch until the broader indices stop falling and get into a rally attempt. We would wait for small and mid-cap indices to show signs of stability and then move into a confirmed uptrend before accumulating related stocks.
If the correction continues then the Nifty Midcap can correct another 15-20 percent (13,650 level) and might see a reversal from that point.
On the contrary, the Small-cap index has started showing early signs of reversal but the strength of the rally can only be confirmed once it crosses 6,500.
What should investors do?
The earnings season is on cards and this is an opportune time to create a watch list of fundamentally strong stocks which are announcing above estimate earnings or an earnings surprise.
There are few stocks which have strong fundamentals and might be a good bet at the current prices. Q2 results for stocks like VIP Industries, Jubilant FoodWorks, Nalco, HCL Technologies, Bata India, Zydus wellness, Thyrocare, Colgate Palmolive and Dabur India should be tracked closely.
We believe investors should not chase IT stocks based on rupee depreciation alone. They should look out for IT stocks that deliver predictable commentary and continued volume growth in the overall business.
In terms of criteria for short-listing stocks, we prefer companies that deliver revenue growth of over 25 percent on a YoY basis in the current quarter and last year.
In the mid and small-cap space, stocks that correct the least during a strong broad-based market correction (like now), should be picked when markets improve.
Technology, retail, pharma stocks can lead a new rally as their fundamentals are intact, and stocks have not lost confidence by losing 40-50 percent of market cap as seen in some other sectors.
Generally, it is important to pick companies that display industry-leading growth and have higher margins compared to their peers driven by strong sales growth.
Most scrips that rallied last year have experienced heavy profit booking and are trading substantially lower than their all-time highs. Some of these small-cap stocks are in consolidation mode and should be bought only when they break out on above-average volume.Get access to India's fastest growing financial subscriptions service Moneycontrol Pro for as little as Rs 599 for first year. Use the code "GETPRO". Moneycontrol Pro offers you all the information you need for wealth creation including actionable investment ideas, independent research and insights & analysis For more information, check out the Moneycontrol website or mobile app.