Small and Midcaps’ Fall: Is it a Repeat of the 2018 Crash? Motilal Oswal Answers (image source: iStock)
The Securities and Exchange Board of India (SEBI) recently raised concerns over pockets of irrational exuberance in the Indian equity markets, particularly highlighting the stretched valuations of small- and mid-cap stocks. This comes amidst large inflows into mutual funds investing in these segments, prompting a closer examination of the market’s dynamics.
Drawing Lines From 2018
In early January 2018, Indian equity markets were characterized by extremely high valuations across all segments, with small- and mid-cap stocks trading at unsustainable premiums over benchmark indices. The market witnessed a significant correction as mutual fund industry-wide rebalancing out of small- and mid-cap stocks took place, exacerbated by factors such as the NBFC crisis and impending elections. However, 2024 presents a different scenario, with a resurgence in momentum observed in the small- and mid-cap segments since April 2023.
“Market momentum in SMID from April 2023, coming off from discounted valuations for Small Caps and strong domestic investor participation in Mid & Small Cap led to a sharp rebound for both their segments, leading to spike in premium over Nifty valuation becoming a concern by early 2024,” said Prashanth Joshi , Senior Vice President, Chief-Products at Motilal Oswal.
Regulatory Intervention And Market Response
Recognizing the potential risks associated with elevated valuations, SEBI took a proactive stance by urging asset management companies to stress test their exposure to small- and mid-cap segments. Additionally, certain asset managers ceased accepting fresh lump sum investments, influencing market sentiment. Simultaneously, banking regulators intervened in sectors such as NBFCs and payments, further shaping market dynamics.
SMID – 2024 Is Not 2018
In contrast to 2018, there is no compulsory industry-wide rebalancing out of the small- and mid-cap segments. Many asset managers continue to explore opportunities in these segments, reflecting a more nuanced approach to market dynamics. Despite recent fluctuations, fundamentals remain robust, with domestic investor participation driven by strong earnings growth in small- and mid-cap companies.
Valuations and Investment Opportunities
Valuations in the small- and mid-cap segments have undergone fluctuations, presenting opportunities for investors seeking attractive entry points. While the current premiums over benchmark indices have moderated, small- and mid-cap stocks remain compelling investment options, supported by high earnings growth estimates and dedicated investment flows.
