Beaten down mid-caps had their day in the sun in the month of October. The Nifty Mid-cap 100 index posted nearly 5% returns, marginally outperforming the key benchmark index Nifty50, which rose 3.5%. Since the last year, mid-cap stocks have been punished and outperformance is rare.

Hopes of festive demand revival, personal income tax cut and decent foreign institutional inflows were drivers of this optimism.

But before one gets carried away, it should be remembered that mid-caps tend to do well when the economy is in good shape. And unfortunately the latest set of high-frequency data doesn’t bring much cheer on that front. Be it automobile sales, goods and services tax revenue collections and manufacturing purchase managers’ index - all reflect anemic demand. Moreover, the latest fiscal deficit data also points to limited fiscal room to immediately dole out further tax sops.

In short, the sustenance of the current up move in broader markets depends on many factors falling in place. According to an analyst with a foreign brokerage, even if some of these measures were to be announced, mid-caps have a large gap to bridge to reclaim earlier highs. He said that bouts of foreign fund inflow may lead to some churn from large-caps to mid-caps, pushing the latter higher. But economic recovery is the key for this counter to consistently beat blue-chips, he added. The brokerage house is currently under weight on small and mid-cap stocks.

To put things into perspective, in this calendar year so far, mid-caps remain laggards losing nearly 6% as against Nifty’s 10% gains. Similarly, small-caps continue to post dismal returns. Further, the Nifty Mid-Cap 100 index is still 23% away from its record high 21840.85 touched in January 2018.

"The up move currently seen in mid-cap stocks is happening after a long streak of extreme sell-off. Some micro developments including better-than expected earnings of select mid-cap stocks may lead to some more gains in such mid-cap stocks. But at the mid-cap index level, the gains from hereon will be muted for some time, Deepak Jasani, head of retail research at HDFC Securities said.

He further added that earnings have to catch-up further for this rally to have more legs. “Also, with strong FII inflows coming in October, traders now seem to be less worried about abrupt selling by foreign investors; so they may be building long positions in mid-caps which were anyway oversold," he said.

Valuation wise, the mid-cap index is trading at a one-year forward price-to-earnings multiple of 15 times lower than Nifty’s 18 times. Although trading at a discount, in the current economic scenario, investors need to tread with caution here. Blindly buying based on one-month's movement may prove to be a costly mistake.


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