Despite several indices showing strong individual performances, the broader Indian markets underperformed relative to benchmark indices in September 2023. The Nifty Midcap index and Nifty Smallcap index reported gains of 1.76% and 1.32%, respectively, but fell short of the Nifty 50 benchmark’s more robust 2.28% increase.
This disparity in performance can be attributed to a market correction stemming from escalating geopolitical tensions, particularly between Iran and Israel. Conversely, large-cap stocks benefited significantly from the U.S. Federal Reserve’s substantial 50 basis points (bps) rate cut during the same month, positioning them for outperformance.
Strong Performance in H1 FY25
In the first half of the financial year 2024-25 (H1 FY25), broader markets experienced impressive growth compared to the Nifty benchmark. The Nifty Midcap index surged by an impressive 25.6%, while the Nifty Smallcap index soared with a 28.5% increase, significantly outperforming the Nifty’s 15.6% growth during the same period.
Year-to-Date Performance Overview
Further analysis reveals that, on a calendar year-to-date (YTD) basis, mid-cap and small-cap stocks continue to lead in performance metrics. The mid-cap index achieved a remarkable 31% rise, and the small-cap index outperformed even further with a gain of 32%, while the Nifty advanced by 18.7%.
Investing in Midcaps and Smallcaps: The Risks
It’s crucial to acknowledge that investing in mid-cap and small-cap stocks carries higher risks compared to their large-cap counterparts. Although mid-caps present opportunities for higher returns, they are best suited for investors with a higher risk tolerance. Conversely, conservative investors may prefer large-cap stocks as a safer investment choice.
Outlook for Broader Markets
Experts have mixed views on the outlook for mid-cap and small-cap segments, which are characterized by high valuations but potential for significant growth. Given the volatility in broader markets, investors are encouraged to adopt a stock-specific investment approach while carefully assessing the associated risks and rewards. Although experts advise caution, opportunities remain for those with a long-term investment strategy.
Expert Insights on Market Trends
Atul Parakh, CEO of Bigul, highlighted that the current mid-cap and small-cap markets present a mixed landscape. While valuations remain high compared to historical metrics, several companies within these sectors have strong business fundamentals and growth trajectories that may justify their present valuations.
He emphasized the importance of a stock-specific strategy, urging investors to focus on individual enterprises rather than relying solely on broad market indices. A contrarian investment approach over a three-to-five-year horizon could yield substantial rewards, balancing upside potential against elevated valuation risks.
Market Liquidity and Risk Management
Aamar Deo Singh, Senior Vice President of Research at Angel One, also advised caution, affirming that liquidity inflows into the markets are unlikely to diminish shortly. He posited that any market correction would likely be brief but warned that significant downturns in U.S. and global markets could catalyze similar reactions in the Indian markets. Profit booking is advisable as many small-cap and mid-cap stocks are currently trading at inflated valuations.
Valuation Insights from Analysts
Krishnan VR, head of the Quantitative Research team at Marcellus, indicated that as of July 2023, the Nifty 500 Index, encompassing small and mid-caps, had a cross-cycle adjusted price-to-earnings (P/E) ratio of 45.5x—placing it in the 99.5 percentile of its values since 2007. This emphasizes that current valuations are historically high. He accentuated the need for a detailed examination of individual companies within the small and mid-cap sectors, given the broad range in earnings growth and business fundamentals.
Final Recommendations
While mid-cap and small-cap sectors have shown strong performance on a year-to-date basis, they come with heightened risks due to stretched valuations and geopolitical uncertainties. Investors are advised to approach this market segment cautiously, focusing on businesses with robust growth potential. Experts suggest that profit booking and a selective strategy for re-engagement with high-risk, high-reward territories may be prudent in the near term.
