Is midcap, smallcap dream run coming to a close? Risk-reward no longer lucrative after mega rally

Amid the current bull run, midcap and smallcap indices have gone previous their earlier benchmarks on a number of fronts.
(Picture: REUTERS)

Midcap and smallcap indices have been underneath the agency management of bulls since home markets began rallying final yr. Outperforming the benchmark indices, midcap and smallcaps have narrowed the valuation hole to giant caps considerably, however with this sharp rise, the risk-reward doesn’t stay profitable anymore, stated brokerage and analysis agency Motilal Oswal. Whereas the Nifty 50 index has soared 43% within the final one yr, the Nifty Midcap 50 has galloped 73%. Equally, the Nifty Smallcap 250 index has zoomed 107% within the final one yr. 

Threat-reward not profitable now

Amid the current bull run, midcap and smallcap indices have gone previous their earlier benchmarks on a number of fronts. Mid caps and smallcaps have recorded consecutive months of constructive returns, 12-month rolling returns hole in opposition to the Nifty has been higher, relative valuations have jumped, and contribution to general market capitalization is up. “The sharp outperformance of midcaps, bolstered by wholesome earnings, improved sentiments, benign liquidity, and low price of capital, has greater than bridged the valuation hole in opposition to giant caps,” they added.

Rising valuations have now eroded the low cost to giant caps, diminishing the risk-reward perspective. “Any risk-off owing to issues over potential rate of interest hikes could influence midcaps/smallcaps extra in our view,” Motilal Oswal stated. 

However dream run won’t be over

Though valuations is likely to be lofty, unlocking the financial system may nonetheless work to learn listed corporations. “Stability sheets and money flows have improved in monetary yr 2021 as corporates tightened prices and deleveraged. The gradual unlocking of the financial system and an improved demand backdrop do provide bottom-up alternatives. Constant earnings supply v/s expectations is important for additional outperformance,” Motilal Oswal stated.

The current broad-based rally has led to a pointy improve in market cap contribution from the Midcap and Smallcap indices. The report highlighted that Midcap 100 index market cap now contributes 12.1% to the general market cap, up from 9.8% in March final yr. In the meantime, Smallcap 100 corporations’ market cap as a share of the general market cap has elevated to three.7% presently, from 2.7% in March 2020. Nonetheless, that is nonetheless beneath the 2017 peak market cap contribution by the midcaps and smallcaps.

Nifty smallcap 100 presently trades at a premium to Nifty 50 for the primary time since 2014 and Midcap 100 valuations are buying and selling on par with the benchmark index. “Nonetheless, if one have been to take away the loss-making corporations from each the indices, then Nifty Mid-cap and Nifty Small-Cap indices are buying and selling at trailing P/E of 21x and 23x FY21 earnings, at a marginal low cost to Nifty,” the report stated.