Hold on to investments in equities, even in mid & smallmidcaps

Basically, the markets have been on fire in the last 4 years. Nifty used to trade at 15x earnings at the beginning of 2014 and is now trading at 23x.

A lot of people have recently raised a query on small & midcap funds. Some of them ask whether it is a good time to invest, and others are asking if they should stop investing in these categories.

Just to put some perspective, BSE Small Cap Index has corrected around 22 percent since January 1, 2018. Similarly, the BSE Midcap Index fell 14 percent during this period. As against Nifty that gained 5 percent.

A lot of people are wondering why the Nifty is almost at an all-time high, whereas the Mid and Small-cap indices are sharply down. Let me give you a break-up. And that will give you an idea that except for a very small number of stocks, most others have been negatively affected during the last 7 months.

Let me try to explain this divergence and my thoughts on the markets.

As you can see from the above table, the upside in the Nifty index has primarily been contributed by just 12 stocks, which basically confirms that the downturn that we are witnessing right now has been broad-based.

There are multiple reasons for the sharp correction that we have witnessed since the beginning of 2018.

The last 4 years, were marked by the rapid rise in the valuation of stocks across all segments.

As you can see from the above table, if you invested Rs 100 in the beginning of 2014, it would have grown 2.5x, 2.5x & 1.6x in small-cap index, mid-cap index and Nifty, respectively.

Basically, the markets have been on fire in the last 4 years. Nifty used to trade at 15x earnings at the beginning of 2014 and is now trading at 23x.

After such a massive rally, the markets are generally expected to cool down for some time. In quite a few stocks, the valuations have run far ahead of the fundamentals as the frenzy gathered steam. During the last 6 months, we have seen quite a bit of correction in valuation in such stocks.

The second reason for the correction is the sudden change in macros. Oil prices have gone up to USD 75 per barrel or so. As a result, our import bill is climbing up. The trade deficit, as a result, will deepen and so will the Current Account Deficit.

Estimates are that in this calendar year, the CAD would be around 2.5 percent of the GDP. These changes have contributed to the depreciation of INR by (-)7 percent in the last 7 months. While world over, all currencies have depreciated against the USD, India is more impacted. Higher oil prices are beginning to impact inflation which has started crawling upwards. To arrest the rise in inflation, RBI has changed its stance on interest rates and have raised the repo rate by 25 bps. All these adverse macros have dented the sentiment in the short term.

The third concern of the market is about the General Election in 2019. People are wary of building the major position in Equities, considering elections and an unfavorable outcome.

Naturally, there are two questions that would come to mind. How long will the correction last? And, what should I do?

In the last few months, valuations have corrected across market cap and industries. Of course, some stocks and sectors have witnessed much sharper correction than others. So, on one hand, the markets may slip a little further if the nervousness persists, but we do not see very sharp falls from here onwards.

On the other hand, it’s been generally seen in the past that once the valuations correct so sharply in the absence of any negative news, the reversal in sentiment also takes time. So our sense is that the markets may have stock specific action based on earnings growth rather than a broad-based rally in the coming months.

From the next 1-2 years’ perspective, there are a host of positives that can drive the markets into a new trajectory –

• Improving corporate fundamentals,

• Rising capacity utilization,

• Improvement in consumption demand from rural and semi-urban areas,

• Rising income levels of farmers due to higher MSPs as well as loan waivers,

• Improvement in employment generation,

• Speedy implementation of large infrastructure projects which have a catalytic effect

• End of NPA cycle for most PSU Banks

• Potential start of capex cycle resulting in higher credit growth

• Strengthening demand for retail credit

• The realization of GST benefits

• Global growth recovery (Global GDP is likely to grow at 3.5 percent next year).

It is quite evident that the macroeconomic parameters improved significantly in the last 4 years primarily because of the sharp fall in oil prices. My belief is that in the next 4 years, it would be the inherent strengths of the Indian economy that would drive improvements in macros.

Looking at all this data, it makes abundant sense to hold on to our investments and keep adding more money to the equity portfolio. By the same logic, one should continue to hold on to the small and midcap funds/exposure and add further.

Yes, there is a major event next year in the form of general election. There is a high likelihood of NDA coming back to power and thereby a stable government. If a coalition government comes to power, there could be the further correction in the market. Having said that, the list of positives I mentioned above are not going to disappear based on who will be the next Prime Minister. So, whether it is NDA that comes to power or a coalition government, markets are going to be substantially higher in the next 3 to 4 years.

Disclaimer:-The views and investment tips expressed by investment experts are their own. Ripples Advisory advises users to check with certified experts before taking any investment decisions.

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