After 16% rally in three weeks, analysts turn cautious on small-caps

Analysts have turned cautious on small-caps after a sharp market rally saw a host of these counters beat their mid-and large-cap peers on absolute return in the past three weeks. The S&P BSE Smallcap index has outperformed the market by surging 16 per cent in the past three weeks as compared to around 15 per cent and 14 per cent rise in the S&P BSE Sensex and the S&P BSE Midcap indices, respectively during this period.

Of the 685 stocks from the smallcap index, more than half or 429 stocks beat the index by gaining over 16 per cent during the period. Total 241 stocks have rallied an over 25 per cent in the past three weeks. Of these five stocks – Khadim India, IFCI, Sintex Industries, LT Foods, and SREI Infrastructure Finance – have surged over 70 per cent, while 39 stocks soared in the range of 50 per cent to 70 per cent.

“A number of these stocks have gone up on account of the ample liquidity chasing them – even those with weak fundamentals. Investors are speculating and chasing higher returns at a time when other avenues of generating a decent return are drying up. While some can still go up further, investors will be better off exiting them at higher levels and investing in stocks of fundamentally sound companies,” cautions A K Prabhakar, head of research at IDBI Capital.

 

Among sectors, capital goods, auto ancillaries, chemicals, constructions, realty, entertainment, financials, hotel & restaurants, information technology (IT), plastic products, steel, sugar, textiles, and tyre sectors have led from the front.

With the past three weeks gain, the S&P BSE Smallcap index has recovered 39.2 per cent from its 52-week low touched on March 24, 2020. In comparison, the S&P BSE Sensex and the S&P BSE Midcap index have bounced-back 35.3 per cent and 32.8 per cent, respectively, from their 52-week lows, hit on the same date.

“Small-caps will take a much longer time to recover as far as earnings are concerned compared to their mid-cap and large-cap peers. Some may even find it difficult to pay the principal and the interest on their borrowings and may fold up. Investors should take money off the table now,” says Gaurang Shah, head of investment strategy at Geojit Financial.

After a highly stringent two-month lockdown, the Indian government is clearly moving toward a step-by-step approach to restoring normalcy. While these relaxations would help improve the supply-side situation, the underlying demand trend remains the key monitorable.

Motilal Oswal Securities expects the governments (Central and State) to progressively keep relaxing the lockdown norms further. As a result, the interplay of health and economic crisis holds the key to how markets behave in the near term.

“Our Nifty target of 9,900 for March-end 2021—with upside/downside scenarios of 11,500/6,700—implies unattractive risk-reward after the recent rally. Labour shortages and the execution of long-term reforms remain key variables,” wrote Gautam Chhaochharia, head of India research at UBS in a June 3 note co-authored with Dipojjal Saha and Tanvee Gupta Jain.