Pain For Small Caps Likely As Large Caps Rebound, Says Marcellus' Saurabh Mukherjea
Influx of retail money, with some margin funding and low free floats, has led to a significant surge in small-cap stocks, he says.
A correction was expected for overvalued Indian stocks and volatility for small caps in particular will likely persist in the coming months, according to Saurabh Mukherjea of Marcellus Investment Managers.
"The fundamental support for small-caps is not there," Mukherjea told NDTV Profit. "I think small-cap valuations correcting over a twelve month period is highly likely."
Small-cap companies have been struggling to make profits for a long time, and it's because bigger companies are becoming more dominant as the country grows, taking away their share, he said.
The Nifty 50 was trading flat on Thursday after it dropped the most in 10 months on Wednesday, retreating from all-time highs. The decline was largely attributed to profit-booking after a record-setting burst fuelled by state election results and U.S. Federal Reserve's signal to pivot next year.
India's benchmark Sensex has risen nearly 16% so far this year and the boarder markets outperformed.
"In situations where there is overvaluation, whether it's in the kind of stocks investors prefer, or in numerous low-quality small-caps, a correction is bound to happen," Mukherjea said.
Why Small Caps Surged
The rally in small-cap stocks over the past few years is unprecedented in Indian history, according to Mukherjea. "I've been looking at the numbers for the last 20 years. I've never seen anything quite like it."
The performance of the bottom half of the BSE 500 lacks fundamental justification and historical precedence, he said. Whether reflecting on Wednesday's market movement, or anticipating ongoing volatility in small-caps, there is no fundamental support for the sustained growth of hundreds of small-cap stocks in the coming months, Mukherjea said.
A modest influx of retail money, coupled with some margin funding and low free floats, has led to a situation where small-cap stocks have surged by significant percentages, without any logical justification, he said.
Retail investors have been drawn to small caps that may seem cheap at first glance due to low price-to-earnings multiples. The combination of this perceived affordability and limited liquidity makes these stocks "very easy to push up", he said.
Yet, the expectation is that even retail investors will shift their focus back to large caps, he said.
Outlook On Large Caps
Large-cap stocks are anticipated to recover with the support from foreign investments, Mukherjea said. They have see an approximate 15% increase and the underlying profit compounding of well-run large companies typically falls within the range of 15-25%, according to him. "I don't think there's any concern at the large-cap end of the market."
Looking at a twelve-month horizon, especially with global interest rates at their peak, political stability in India's future and robust balance sheets of corporate India, he sees little reason to expect a selloff in India's large caps.
The Indian banking system has accumulated substantial capital, making it resilient, Mukherjea said. Foreign investor flows will likely enter the market in the next twelve months, buoying large-cap stocks, particularly those that have been discussed over the years, he said.
