Historically, the monthly returns of S&P 500 are mostly negative in September. An anomaly which is believed to be a season behaviour having an effect on the performance of global stock market annually. In the current month, Indian markets have indeed marked increased volatility. Among different market segments, mid- and small-cap stocks have borne the brunt of this volatility, while large-cap stocks have remained relatively stable. The direct consequence of this volatility is increased selling pressure from FIIs and HNIs. The selling in India by foreign investors is collateral damage resulting from the adverse performance of global equity.
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The global market is currently grappling with consolidation due to a sluggish economy teetering on the brink of high inflation and sustained high-interest rates. These factors pose significant challenges to future growth prospects by dampening corporate and household spending. Secondly, both factors are leading to elevated bond yields, which is unfavourable for the equity class, reducing forward valuation, it is important to note the inverse relationship between bond yields and earning yields, which adds complexity to the investment landscape.
This trend has resulted in substantial selling across emerging markets, including India. Maximum selling is recorded in countries like Japan, Taiwan, China, and the Euro Area, in the month of Sept. In the Indian context, the level of selling by FIIs has been relatively moderate. This can be attributed to the belief that the domestic economy is poised to decouple from the global economic trends, driven by industrialization and favourable business policies. It is important to note that the impact of FIIs’ selling activity is cushioned by the positive inflows from DIIs and Retail investors. Net selling by FIIs is ₹16,026cr on 27th Sept while net inflow from DIIs is ₹14,230cr as on 21st Sept.
During this month, selling was also noticed at HNI’s desk especially in the mid & small counters. Maybe contemplating to book profit after the solid performance of the category in FY24 during April to August. The Nifty midcap and Nifty small caps index are up by 38% and 45% in the last 6months. Due to the sharp rally, it is rational to assume that short-term performance may see constrains. However, we feel that the medium to long-term trend is expected to be maintained, supported by domestic earnings growth, which is forecasted to hold a multiple effect compared to large caps. Secondly, the valuations are not at a bubble level, like the Nifty small caps 100 index, which is at a one year forward P/E of 16x, which is the long-term average, assuming healthy earnings growth.
Another point tinkering the mind of investors is that, can the performance of Mid & Small caps be influenced by the deployment of ASM on SME stocks. The implementation of ASM in the month of October will have a ripple effect on the performance of SMEs. However, the exact interplay and impact of this on Small-cap stocks are speculative at this stage.
SME are small businesses with a capital size of less than ₹25cr, often confront more significant challenges compared to larger establishments. They are generally riskier in nature than small-cap stocks, which themselves carry inherent risk within a given business cycle. Hence if there is a slowdown in business and the stock market both will be most affected. The NSE SME index is up by 75%, and the BSE SME IPO index is up by 132% in the last year as of 31st August, compared to 10% by Nifty500. The valuation of the SME index based on trailing P/E is elevated from 48x to 52x with a dividend yield of 0.04% to 0.13%, respectively. However, the total market capitalisation of SME stocks trading in BSE ( ₹26,800cr) is merely 0.08% of India’s capitalisation.
The current trend of SME is primarily driven by intense speculation surrounding small-sized IPOs, which have experienced multiple instances of oversubscription over the past 2-3 years. For example, in the year 2023, a total of 135 SME raised ₹3,650cr with an issue range of ₹2cr to ₹105cr. The average oversubscription was 76 times in a range of 0.2 to 730 times.
MFs follow an investment philosophy and avoid investing in SME groups. The substantial influx of funds into small-cap MF schemes should not be associated with the rise of SMEs. Rather, the significant discounts in valuation and performance when compared to large and mid-caps. Nevertheless, given the recent strong performance, it is anticipated that small-cap stocks will experience a short-term moderation. One notable characteristic shared by SMEs, micro-caps, and small caps is their liquidity. Given the prolonged negative FIIs inflows led by weak performance of the global market and slowdown in micro, small & SME rally, this can have a side effect on the India market especially in the short-term, affected by slowdown in direct equity investment from retail and HNI investors.
Author of the article, Vinod Nair, is the Head of Research at Geojit Financial Services.
Disclaimer: The views and recommendations given in this article are those of individual analysts. These do not represent the views of Mint. We advise investors to check with certified experts before taking any investment decisions.
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Updated: 01 Oct 2023, 01:48 PM IST