Small-cap stocks may continue to beat large-caps next year in India

India’s smaller stocks are beating their larger peers for the first time in three years, and some strategists say that outperformance will likely continue at least through next year.

The Nifty Midcap 100 Index has climbed 20 per cent this year, and the Nifty Smallcap 100 Index has advanced 17 per cent, outpacing the 11 per cent gain in the large-cap NSE Nifty 50 Index. While the Nifty has set a series of new records this year, the smaller gauges remain below their peaks after two years of losses.

Broadly strong corporate earnings, efforts by the government and central bank to bolster the economy, and a surge in retail trading have helped smaller shares start to outperform since summer. And while the Nifty’s price-to-earnings multiple has reached an all-time high, the small- and mid-cap gauges are trading at similar valuations to late 2017, the last year they outperformed the larger index.

“Such turn in performance does not fizzle out so fast, especially when the valuation gap is still there,” said Vinod Karki, head of strategy at ICICI Securities, the nation’s largest listed broker. “High liquidity and prospects of economic recovery are perfect recipes for relatively riskier assets such as smaller-sized companies.”

The measures of small- and mid-cap stocks fell over the last two years as concerns over slowing economic growth drove investors to the safety of their larger peers. Covid-19 initially fanned such concerns, casting doubt on the ability of smaller companies to withstand a nationwide lockdown that drove most business activity to a standstill.

Now there are hopes for a rebound. India’s gross domestic product shrank a less-than-expected 7.5 per cent in the three months ended September, a marked improvement from the June quarter’s record 24 per cent contraction. The outlook for earnings has improved as a slew of indicators suggest a gradual recovery in activity across the key services and manufacturing sectors, as well as a gradual revival in consumption.

“We believe that the lead current indicators on earnings and sentiment are supportive of a significantly new high over the next 18 to 24 months for the mid-cap and small-cap indexes,” said Amit Khurana, head of equities for Dolat Capital Market. “Going forward, economic recovery, expectations of sustained customer demand and liquidity will drive gains.”