After a dismal FY23, is the tide turning for mid, small-cap segments?

The S&P BSE Small-cap and Midcap indices have surged around 6 per cent and 4 per cent, respectively, as against a 2 per cent gain on S&P BSE Sensex so far in FY24.

The mid-and small-cap segments at the bourses have outperformed their larger peers thus far in fiscal 2023-24 (FY24). While the S&P BSE Small-cap index has surged around 5.7 per cent in FY24, the S&P BSE Midcap index has gained 4 per cent during this period. In comparison, the S&P BSE Sensex has moved up around 2.2 per cent.

The recent surge in the mid-and small-caps, according to Gaurang Shah, senior vice-president, Geojit Financial Services could have been triggered by some fund houses buying into these segments. However, he suggests investors remain cautious and do not jump in just yet to buy stocks from these two segments.

“Investors need to be cautious as regards mid-and small-caps. The recent outperformance needs to sustain and has to be backed by an improvement in earnings as well. One cannot paint the entire mid-and small-cap segment with a single brush. Instead, there will be pockets of outperformance and underperformance. I suggest a sector-specific and a stock-specific approach if one has to invest in mid-and small-caps,” he said.

Granular data from mutual fund portfolios within ‘market capitalisation’ funds category indicates that buying by mid -and small-cap funds outpaced large-cap funds, suggests recent ICICI Securities report. It estimates March 2023 flows at Rs 2,726 crore in the small-cap funds category and Rs 2,890 crore for the mid-cap fund category. This is in comparison to flows of Rs 1,020 crore in the large-cap fund category. These flows, in turn, would have seeped into the stocks at the bourses, analysts said.

The reversal in fortunes of these two segments at the bourses comes after a dismal FY23 when both these segments underperformed their larger peers. The S&P BSE Smallcap index ended FY23 with a loss of 4.5 per cent, while the S&P BSE Midcap index lost a marginal 0.2 per cent. In comparison, the S&P BSE Sensex had gained 0.7 per cent in the fiscal year gone by.

The sharp fall in the mid-and small-caps in FY23, according to G Chokkalingam, founder and head of research at Equinomics Research & Advisory, has also now made valuations attractive for a large number of fundamentally sound companies in these two segments. As a result, investors are preferring mid-and small-caps over their large-cap peers.

“In my opinion, FY24 will be a year of mid-and small-caps after their dismal show in FY23. The retail investors are slowly turning positive on the overall markets and their first port of call are these two segments. Valuations, too, in some cases have turned favourable. I think it is a good time to cherry pick stocks from the mid-and small-cap segments from a medium-to-long term perspective,” Chokkalingam said.

Over the next few weeks, the key monitorable for the markets include the upcoming Fed policy and the accompanying commentary (whether the Fed pivots), the progress of the global markets post the recent rally, further estimates on monsoon back home and the March 2023 quarter (Q4FY23) earnings season. Apart from the actual numbers, the markets will also remain focused on the post-results corporate commentary, especially related to the demand environment and the margin trajectory with the softening of the input costs providing some respite. All this, analysts feel, will be key to how the flows into the equity markets pan out as well.

“Once we see the last Fed rate hike, the dollar is also expected to weaken further. This should be positive for commodities and emerging markets. With emerging markets likely to be favoured, FII flows into India will start improving during the second half of the year,” said Mahesh Patil, chief investment officer at Aditya Birla Sun Life AMC.