Midcap, smallcap stocks rebound from CY18 lows. Analysts remain cautious

After tumbling 13 per cent and 14 per cent respectively when the frontline index, the S&P BSE Sensex, was at its peak level of 36,283 on January 29, 2018, the mid-and small-cap indices on the Bombay Stock Exchange (BSE) have staged a partial recovery.
 
Both indices moved up for the fourth straight session this week with a gain of 2.7% and 2.5% respectively, as compared to 1.4% rise in the S&P BSE Sensex. On a year-to-date basis, however, they still remain underperformers with a fall of eight per cent, as compared to less than one per cent fall in the S&P BSE Sensex.
 
“Markets can dip further over the next few months, with a bulk of this fall coming from a correction in the mid-and small-cap segments. There are a lot of stocks where there is no valuation comfort, especially in the textiles and steel sectors. The public sector bank (PSB) fraud also hit sentiment. That apart, the pace of flows – both domestic and foreign – has slowed down a bit. All this will continue impacting the momentum going ahead,” says G Chokkalingam, founder and managing director at Equinomics Research.
 
The fall in mid-and small-cap segments comes after a stellar performance in calendar year 2017 (CY17). While the midcap and smallcap indices recorded a gain of 48 per cent and 60 per cent respectively in CY17, the S&P BSE Sensex had rallied 28% during this period.
 
Over half, or 551 stocks, from the midcap and smallcap indices have slipped over 10% thus far in CY18 with a bulk of companies from the commodities sectors such as steel, sugar, chemicals, textiles, auto ancillaries, realty and financials (mainly public sector banks).
 
“Markets had rallied sharply in the last one year, and these two segments had run up even more. Valuations, too, were terribly steep. Going ahead, the only silver lining for the markets is an improvement in macro-economy, which in turn, results in pick-up in corporate earnings. That said, investors need to be very selective as regards mid-and small-caps now,” cautions Vinay Khattar, associate director and head of research at Edelweiss.

Among individual stocks, Gitanjali Gems, Electrosteel Steels, GTL Infrastructure, Bombay Rayon Fashions and Jaypee Infratech have seen their market value erode between 60% and 80% thus far in CY18.
 
Parsvnath Developers, BLS International, Flexituff International, Agarwal Industrial Corporation, Bhushan Steel, Siti Networks and PG Electroplast have slipped 40% to 50% during this period.
 
Over the next couple of months, Chokkalingam expects the mid-and small-cap indices to correct around five per cent. This, he says, will be due to the lack of funds chasing stocks in these segments, high valuation of select counters and regular profit booking. “Investors will be better off either staying away from these two segments, or investing only where there is earnings visibility and valuation comfort,” he advises.
 
On the other hand, specific to mid-and small-cap segments, Rana B Gupta, managing director, India Equities at Manulife Asset Management (Singapore) sees opportunities in areas like organised retail, consumer durables, white goods, domestic pharma, logistics, staffing services and real estate. “All these sectors are also beneficiaries of substantial value transfer from unorganised sector due to ongoing formalisation of the economy,” he says.