Indian equity market witnessed divergent trend over last few years (2009-13). While the large cap stocks and market index such as Sensex and Nifty remained in positive territory most of the time, the mid cap and the small cap stocks found their place in negative territory. This has been against normal market phenomena wherein the frontline indices (Sensex/Nifty), the mid-cap index and the small-cap index move in similar direction, though their performance may differ during different periods. One apparent reason has been that investors preferred to reduce risk during this period and focused on companies with stronger cash flows and stale businesses, instead of companies with high capex requirement and shaky business model.
However, large cap stocks and frontline index stocks gradually became over-owned by investors; valuation of these stocks became expensive and moved beyond investor’s comfort zone. This paved the way for turnaround in the mid cap and small cap stocks. Starting October 2013, the mid cap and the small cap stocks staged a strong turnaround as investors started looking beyond large cap stocks and frontline index stocks.
Chart 1: Performance comparison (Large Cap Vs Mid Cap Vs Small Cap)
As investors move beyond the large cap stocks, they will fish for stronger companies in sectors wherein the business cycle is bottoming out or has already bottomed out. From valuation perspective too, investors are finding the mid cap and the small cap stocks relatively attractive.
Chart 2: 2014 Year to Date (YTD) performance of large cap, mid cap and small cap stocks
Having said that, the small cap and the mid cap stocks are always the first one to bear investor’s wrath when market become volatile and investor sentiment turns bearish. We can see from Chart 2 that the small cap and mid cap stocks are once again underperforming the market on 2014 YTD basis. In India, attention will be centered on relatively more towards politics rather than economics till general election; investors will most probably keep their finger crossed. This calls for cautious and selective stock picking from the small cap and the mid cap space even though broader investment turns in favor of the mid cap and the small cap stocks.