A correction of 5-10% in small midcaps augurs well for market, says Gopal Kavalireddi of FYERS

Market Outlook

Gopal Kavalireddi, Head of Research, FYERS, is a great believer in starting small but smart. As mid and smallcap stocks took a beating recently, he has a gentle reminder—all largecaps started as small or as midcaps. A sustainable business model, good fundamentals and some headwinds along the way contributed to their rise and these are factors that investors should also keep in mind while picking stocks.

In an interview to Moneycontrol’s Kshitij Anand, Kavalireddi says investors should wait for the markets to stabilise and then evaluate how they want to continue investing in mid and small caps. Edited excerpts:

What led to a selloff in the small & midcaps space? Was it because of the additional surveillance measures introduced by the BSE?

A combination of factors is led to the selloff in the market. On the international front, higher inflation, US Fed taper commentary and better US jobs data played their part.

On the domestic front, the steep rise in small and midcap indices vs the Nifty, a flurry of expensive IPOs and rising IPO funding costs have been troubling investors.

Now, with the BSE circular highlighting the restrictions on the price movement of around 2,000 stocks exclusively listed on that exchange, investors are making a beeline to get out of small and midcaps. This “Add-on Price Band Framework” guidelines will come into effect from August 23, 2021.

Every initiative introduced by SEBI and stock exchanges to maintain market integrity and curb excessive price movement in securities over the years— Graded Surveillance Measures (GSM), Additional Surveillance Measure (LT-ASM), Short-Term Additional Surveillance Measure (ST-ASM), Trade for Trade (TT), etc—have resulted in a vicious correction in stocks, particularly small and mid-cap segment of stocks. But this too shall pass and a favourable outcome can be expected soon.

What should be the strategy of investors with respect to the small & midcaps space?

The Nifty Midcap 150 index is testing the neckline of a small ascending-broadening pattern, a pattern that comprises higher highs but identical lows. The lower neckline of this pattern is around 10,200.

Further, the 55-day simple moving average and the Ichimoku upper cloud support also converged near 10,200. Hence, for the short-term, 10,200 is an important support for the index.

If it remains below this for a day or two, we could see a further 5-6 percent correction in the days ahead. However, if the index finds stability near 10,200 over the next few days, one could start looking out at quality stocks from this space backed with strong fundamentals and good relative strength.

Meanwhile, for the Nifty smallcap 250 index, the corresponding short-term support to watch out for is around 8,400. In fact, the 55-day simple moving average, which is placed at around 8,598, has acted as a strong support for index ever since it crossed this moving average in June 2020.

Hence, one needs to observe the price action between 8,400 and 8,600 in the coming days. Another thing to note is that the smallcap 250 index has seen a 9 percent correction over the last few days.

This is in line with the typical price corrections we have seen in this bull market, which started in April 2020. During this period, the smallcap 250 index has seen corrections ranging from over 5 percent to under 10 percent.

Investors could wait for the markets to stabilise, which could take a few days to a couple of weeks, during which small and midcap indices could go through a price and time consolidation, post which one can evaluate the continuing prospects for further investing.

After a sharp rally (almost a vertical move) seen in the small & midcaps, where is smart money moving—towards IPOs or largecaps? 

After a fall of 5 percent in midcap and 8 percent in the smallcap indices, the returns to date from these segments are 30 percent and 39.76 percent, respectively.

In comparison, the Nifty has delivered returns of only 16 percent. Since the last one year, the Nifty midcap index is up 66.8 percent, Nifty smallcap index 84.4 percent in relation to the Nifty 50, which has given only 43.3 percent return.

The outperformance is very large, resulting in frothy valuations across small and midcap stocks. A healthy correction of 5-10 percent augurs well for the market and would make these segments favourable again.

It is in the investor’s best interest to follow the earnings growth and look for stocks that have delivered a superior financial performance in Q1FY22.

These could be from any of the market cap segments but considering that largecap stocks haven’t performed on expected lines till date, one could look at this segment for investing.

Any small & midcaps worth looking at after the recent selloff and why?

The bottom line for any investing—short term or long term—should be about earnings growth. Investors have the advantage of evaluating the current financials, make a list of stocks with promising prospects, and invest based on their entry strategy and market conditions.

A point to remember: every largecap stock was once a micro-cap or smallcap or a mid-cap stock. The journey starts from there and backed by a sustainable business model, good management, evolving fundamentals, supported by timely regulatory tailwinds and macro as well as microeconomic factors, they have risen to become largecap stocks.

Hence, it’s imperative that investors be part of that journey, aiding them in building wealth, over a period of time. Appropriate risk management strategies, optimal position sizing and investing in the right companies at the right time, on verge to make an investor wealthy.

Start small! Make it large and sustainable over time.

Disclaimer: The views and investment tips expressed by experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.