Small, midcap carnage continues
June 2018 was a mixed month for global indices. Within the US, the technology heavy indices outperformed the Dow Jones (which has a higher weightage to traditional heavy industries), which declined on a month on month basis. Within Asia, weakness was seen in China, while Japan and India ended marginally higher.
On a YoY basis however, all major markets have done well, rising in the range of ~4% to 25%. In the calendar year till date, the Sensex is up by 4%.
Within India, weakness was seen in stocks from the small and midcaps spaces with the benchmark indices - Nifty Smallcap 100 and Nifty Midcap 100 down by as much as 8.3% and 3.8% respectively during the month gone by. On the other hand, the Sensex and Nifty 50 held their ground.
In the past six months, the small and midcaps have underperformed their larger counterparts considerably falling by 21.1% and 14% respectively, while the Sensex and Nifty 50 have risen by 4% and 1.7% respectively.
Coming to sectoral performances, weakness was seen in stocks across the board barring those from the pharma, IT and FMCG spaces; their representative indices were up by 11.6%, 2.4% and 0.5% respectively during June 2018. Stocks from the realty, infra, and media spaces were amongst the least preferred.
On a YoY basis, the IT index (up ~38%), energy (up ~15%) and metal (up ~15%) were the top performers while pharma (down ~5%) and auto stocks (up ~1.5%) have underperformed.
Institutional activity in the month gone by reflected the weak market sentiments as foreign participants continued to be net sellers for the third consecutive month. While domestic funds were net buyers, the additional amount invested was the lowest seen in past seven months and the second lowest amount since April 2017. Domestic institutions invested a net amount of ~INR 65 bn in June 2018. Foreign investors remained net sellers with a net outflow of ~INR 19 bn during the month.
In the calendar year till date, DIIs invested a net of INR ~655 bn versus the net inflow of INR ~15 bn amount of FPIs.
Key highlights in the month gone by
The RBI hiked interest rates by 25 basis points in its second bi-monthly policy review due to concerns related to higher inflation and crude prices, amongst others. Post the decision, the repo rate, reverse repo rate and the MSF rate have been increased to 6.25%, 6.00%, and 6.50% respectively.
The central bank kept its GDP growth forecast unchanged at 7.4%, highlighting that the investment cycle is recovering and is expected to remain robust, as indicated by improvement in capacity utilization and credit offtake. Investment activity is likely to get further thrust amidst robust global demand that is expected to support exports along with resolution of stressed assets which will unlock capital stuck in stalled projects.
While concerns over the weaker Rupee have also emanated, as per Moody’s, India is amongst the least vulnerable to the US Dollar strengthening. As per the rating agency, this is due to the low dependence on external capital flows. As per Moody’s, India amongst other countries will largely be able to fund itself given the higher proportion of savings. Other countries which are less vulnerable (as per the rating agency) include China, Brazil, Mexico and Russia.How have our recent recommendations fared?
With mid and smallcaps being the favoured category of equities in calendar year 2017, the sharp correction seen in these stocks over the past two quarters has shaken up market sentiments considerably. As has been the case in past market cycles, a prolonged outperformance of small and midcap stocks (versus their larger counterparts) does tend to get reversed whenever the market sentiments turn sour, eventually resulting in sharp underperformances in a fairly short period.
A key reason for this sharp decline has been the valuation and earnings growth remaining out of sync. For instance, the trailing 12-month price to earnings ratio of the midcap index expanded by more than 2x over the past three years, eventually leading to a sharp divergence between the earning growth and index movement. Such situations rarely turn out to have a favourable outcomes.
Not to mention that the lack of investment options and abundance of liquidity in the system (post demonetization) have been one of the main factors driving the broader markets. But while one may believe this is a structural change, we would like to stick our neck out and say that we will bet on the human nature (which rarely changes) coming out on top i.e. historically, very sharp increases in domestic inflows into mutual funds has more often than not, been a sign of markets heating up. This time around as well, it seems to be the case.
As we have been reiterating for the past few months, we believe a key question to answer is whether the capital inflow momentum will continue into equities by the Indian households. This we especially say given the historical trend of funds drying up (albeit with a lag) post a dull market performance. As such, we would be surprised (maybe positively in this case…) if things play out any differently this time around.
Additionally, the busy political calendar (state elections) towards the end of the year as well as the news and sentiments leading up to the general elections will keep the markets on their toes; the stock market is bound to swing to developments and new flows emanating from this political arena.
To add to this, all eyes will be on the results for the quarter ended June 2018, which will start flowing soon.
As has been our view since the start of the year, the aim for equity participants (read long term investors and not speculators) is to build wealth. And to do so, one would essentially need to do as well or better than the broader market in both, a rising or falling environment.
Outperforming the market in a declining environment would essentially require one to fall less than the rest. And to do so, investors largely have two options – sit on cash or invest into companies where the downside seems capped (read favourable valuations) – or a mix of both. Notwithstanding the dull market sentiments in the past two quarters, we believe this should be the game plan for investors over the short to medium term.
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