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Read More >It is 'MayDay' in the Indian midcaps this 2018
Publish date: 24th May, 2018
Small- and mid-cap shares have taken a beating in the recent stock market sell-off. Many of the stocks in BSE MidCap index have fallen by as much as 36% and some of the stocks in the small-cap index have fallen over 70% between February and 22 May, 2018. This month, the mid-cap index tumbled over 8% so far - making May, 2018 the worst month for mid-cap stocks since 2006.
Many pundits point out that small- and mid-caps tend to fall more than the market during bear cycles. This is because they experience much higher volatility than large caps.
However, this time, there are other reasons behind the fall in midcaps. Here’s a look:
Expensive valuation:
Many fund advisers have been advising new investors to stay away from small- and mid-cap stocks since January 2018. This has been because after a sustained rally in 2017, most of these stocks were overheated. Even after the recent correction, the valuations are expensive as trailing PE for mid-cap index is 29.7 times and for small cap it is 84.75.
Why this matters: PE measures how much rupees you pay for each rupee of profit earned. So, if you buy a stock with a PE of 45, it means, you pay Rs 45 to each rupee of profit earned by the company. Naturally, the higher the PE, the costlier the stock’s valuation.Reclassification of mutual funds:
The reclassification of mutual funds by SEBI has also had an impact on the share prices. As per the new guidelines issued by SEBI, a mid-cap mutual fund should now have at least 65% of its assets invested in mid-cap stocks and a large-cap mutual fund should have at least 85% of its assets in large-cap stocks.
Why this matters: This has meant that many fund houses have had to adjust their portfolios by selling off small- and mid-cap stocks they were invested in.Weakening rupee:
Much of the rally last year was driven by portfolio management services managing investments for NRIs and foreign investors. With the interest rates on the US$ expected to rise faster than the rupee, the Indian currency has been weakening against the US$.
Why this matters: A fall in Indian rupee’s value against the dollar leads to a fall in returns in dollar terms for NRIs and foreign investors. As a result, they have sold Indian stocks worth over Rs.2,700 crore in May, as of 22 May, 2018. In April 2018, FIIs offloaded shares worth Rs.6,209 crore.Pressure of liquidity:
Crude oil prices have increased by about 20% since the start of 2018. But if you compare with last year, the crude oil price is 50% higher today. These prices are not expected to recede any time soon.
Why this matters: A rise in crude prices affects actual disposable income available with households and limits the investments they are willing to make. Further, it also has an impact on borrowing rates. All these factors coupled with rising yields on 10-year government bonds indicate that cost of capital in India is rising. The yields are already at 3-year high; it may rise further as the government may decide to boost spending in the run up to the elections. This means fixed-income instruments like FDs and Bonds could see higher returns, which makes small- and mid-cap stocks less attractive.
The bottom line
How you should react to these changes will depend on your current portfolio and the exact shares that you are invested in. You can read about how to react to the midcap sell-off here.
