Mid and small-cap stocks, which had a difficult last year, can get their mojo back in 2020, say domestic fund managers. They expect the stocks of smaller-sized companies to start staging a strong recovery after the economy starts to respond to the government’s efforts to revive growth.
"Mid- and small-cap stocks can be attractive investment opportunities for the next year, following the lack of broader market participation for the last two years. Valuations have slid to reasonable levels, limiting further downside," says Anoop Bhaskar, head of equity at IDFC Mutual Fund (MF).
"Divergence between the Nifty and mid- and small-caps has been close to historical extremes. While it is difficult to spot the bottom, historically, broader markets tend to outperform for 18-24 months after such extremes are reached," says Pankaj Tibrewal, equity portfolio manager at Kotak MF.
In 2019, the BSE MidCap had slipped 15 per cent before the corporate tax cut in September led to market recovery. The BSE SmallCap had corrected more than 17 per cent during the same period. In 2018, the BSE MidCap had corrected 13.4 per cent, while the BSE SmallCap had corrected 24 per cent.
Whenever the price-to-earnings (P/E) valuation of small-caps has gone down to 40-45 per cent of the Nifty, there tends to be a bottoming out, say fund managers. The Nifty is currently trading at around 14.5 times its one-year forward P/E multiple.
Also, the share of market cap of the Nifty SmallCap is currently 5.3 per cent of the market cap of the Nifty, which is close to its lowest levels seen in six years.
"At close to these levels in the past, we have seen a bottoming out of mid- and small-cap stocks," says Bhaskar.
Amid weak sentiment, even quality mid- and small-cap stocks have come under heavy selling pressure, say market experts.
"Good quality stocks in this segment had to face collateral damage because they happened to be in this segment. Such stocks offer strong opportunities for next year," says Ambareesh Baliga, independent capital markets professional.
Further, higher liquidity in the banking system can help smaller companies, which tend to suffer when interest rates are on the higher side.
"There is enough liquidity in the overall banking system. This should lead to transmission of credit to the economy," says Tibrewal.
"These companies often find it difficult to convert their earnings before interest, tax, depreciation, and amortisation into profit before tax when interest costs are higher," adds Bhaskar. However, foreign investors are still circumspect of a strong broader market rally
"Narrow market performance should continue at least till mid-year as uncertainty stays high, but we must start reducing concentration risk," Credit Suisse said in a recent note.
Brokerages say that going ahead, revival of domestic economy will be crucial and on the global front, the trading relationship between the US and China will be a key factor to watch out for.