Stock markets in India took off with a big bang in the year 2020. Sensex and Nifty hit new lifetime highs of 42,273.87 and 12,430.50 respectively in January 2020 fuelled by a rally in large caps stocks.
Indian stock markets touched these new highs after several months of extreme volatility which started off with the default of infrastructure financing major IL&FS in September 2018 which triggered a huge selloff in NBFC stocks.
Trade wars between two of the biggest economies USA and China in the first half of 2019 only made matter worse with stock markets in India experiencing severe ups and downs. A proposed surcharge on FPI in the Union Budget 2019 further worsened the situation with unprecedented outflows in FII investments. But things started taking a reverse turn after the FPI surcharge was withdrawn by the government.
However, the current rally in the stock market this also means that many of the large caps have become expensive and over-valued. As a result, even if these companies report strong earnings growth in final quarter, their near to medium-term returns are expected to remain muted.
Fear of a slowdown in China due to the outbreak of the Coronavirus and its possible ripple effect across global economies have put a temporary speed-breaker in the path of Indian stock markets. Read more.
Investing in large caps stocks at over-stretched valuations means getting trapped at higher prices, if a significant correction happens. So, as an investor one can either wait for a significant correction in the stock markets in India to invest in large caps or look at the next better option - investing in small and midcap stocks.
Before that, let's first understand the reason behind the plunge in the prices of smallcap and midcap stocks in the stock market.
- Small and midcap stocks took a big hit post the IL&FS default in September 2018, resulting in a liquidity crunch among non-banking finance companies (NBFC). Due to this, banks turned wary of lending to them. As a result, there was a massive sell-off in NBFC stocks, which then spread like wildfire to the rest of the market.
- SEBI's directive asking mutual funds to re-classify the holdings of their schemes as large, mid and smallcap stocks, added fuel to the fire as mutual fund houses recategorized their schemes to comply with the instructions.
- A slowdown in the economy and a series of corporate bond defaults one after the other prompted investors to dump their small and midcap stock and play safe by investing in large caps companies.
Large caps stocks too had taken a hit post IL&FS default and accompanying credit crunch in the market. However, in the last few months, they have not only recovered but also out-performed. On the contrary, recovery in small and midcap stocks in the stock market in India has been very selective.
A look at the below graphs reveals that Nifty midcap and smallcap index has hugely underperformed in comparison with Nifty 50.
Nifty Smallcap 100
Nifty Smallcap 100 corrected from 9,580.30 on 15th Jan 2018 to a low of 5,207.15 on 22nd Aug 2019 and is currently trading at 6,190.80 as on 11th Feb 2020.
Nifty Midcap 50
From a high of 5,702.70 on 8th Jan 2018, the Nifty Midcap 50 corrected to a low of 4,120.39 on 22nd Aug 2019 and is currently trading at 4,948.40 as on 11th Feb 2020.
Compare this with Nifty which corrected from 11,130.40 on 29th Jan 2018 to 10,030 on 26th Oct 2018. It not only recovered, but also touched new highs of 12,430.50 on 17th Jan 2020.
This circles back to the old question: Should you invest in smallcap and midcap stocks in the stock market in India now?
They Are Available At Attractive Valuations
Many midcap and smallcap stocks which corrected sharply are currently available at attractive valuations now in the stock market.
The Economy Is Showing Signs Of Recovery
Let's look at some data which validates this.
- We are witnessing an increase in passenger cars and utility vehicle sales of India's largest car maker Maruti Suzuki.
- Recovery In Corporate Earnings For The Quarter Ending Dec 31, 2019
The above pointers indicate that the worst may be behind us. As the economy recovers further, the earnings growth of mid and smallcap companies are also expected to increase as they are closely linked to the domestic economy.
Positive Measures Introduced in Budget 2020
To boost the participation of FPI and FII investors in the stock markets in India, the government has introduced a series of measures in the Budget 2020. These measures include removal of Dividend Distribution Tax for corporates, increase in foreign portfolio investor's limit in corporate bonds and 100% tax exemption for sovereign wealth funds for investments in priority sectors.
These moves are expected to be highly beneficial to foreign investors resulting in a higher increase in investment inflows from them. As large caps stocks are significantly over-valued now, most of these funds are likely to flow towards small and midcap stocks. Know more.
What should you do as a value investor?
We have seen various reasons why 2020 is an excellent year to invest in small and midcap stocks for exceptional gains over the next few years. However, don't forget the higher risk levels associated with them.
Hence, it is essential to diversify your portfolio adequately by having a mix of quality small, mid and large caps stocks. We can help you in creating a winning stock market investment portfolio of 15-18 high quality stocks.
While the growth potential of small and midcap stocks is much higher when the cycle changes, it is equally important to have a portion of large caps stocks for stability. Lastly, stay committed to your goals and don't indulge in excessive churning when the tide changes.