Market players say the improvement in market breadth is on the back of shift in investor interest towards mid- and small-cap stocks, where valuations have declined to their long-term averages. In comparison, the valuations for the benchmark indices are currently well above their long-term averages.
According to the Bloomberg data, the BSE MidCap currently trades at 19x its one-year forward earnings estimate. The BSE SmallCap trades at 16.2x, while the BSE Sensex is trading at 18.98x its one-year earnings estimate.
This gap in valuations is prompting many investors to aggressively consider shares in the broader market, said analysts.
“Since March 2019, our preference is for mid-caps over large-caps, and we maintain that view. Whenever mid-caps have underperformed large-caps by 20 per cent in six months, they have historically offered a good buying opportunity. Secondly, in terms of overall valuations, the Nifty MidCap index is trading at a 20 per cent discount to the large-cap Nifty index, which is compelling,” said Jitendra Gohil, head of India equity research, Credit Suisse, in a note.
Some market players said regime continuity is another reason for the broad-based rally in stocks, as investors are hoping there will be continuity in reforms, with the return of a stable government with a more significant mandate.
Further, there are hopes that the Narendra Modi government will announce pro-growth reforms that will help the overall economy. Investors expect the government to push through some tough reform measures such as easing of land acquisition and labour laws.
“With new and affirmative mandate for the Bharatiya Janata Party, foreign as well as domestic inflows are expected to improve. This gap in valuations (between small- and large-caps) is likely to dwindle. We feel there is significant opportunity to generate Alpha in this space. With the benign inflation outlook, we expect the Reserve Bank of India to be incrementally dovish on interest rates. This will enhance liquidity, which, in turn, will help mid-caps and small-caps outperform over the next three years,” said Shailee Parekh, analyst, Prabhudas Lilladher.
The BSE MidCap index rose by 1.39 per cent in May, after falling almost 4 per cent in April. Barring March, the BSE MidCap index fell during all months this year. Similarly, the BSE SmallCap index rose by 1.66 per cent in May, after giving negative returns for most of 2019.
The latest uptick in the broader market comes after a year of sharp underperformance. In 2018, BSE MidCap stocks fell by 13 per cent and BSE SmallCap index by 23.5 per cent.
However, some market participants expressed concerns on how sustainable this rally could be, as the underlying issues in mid- and small-cap stocks like liquidity crunch and tepid earnings growth are yet to be fixed.
“This bounce may last for one or two months. After that, we may see the ADR falling. We see this trend every third or fifth month of ADR rising and then flattening or falling,” said Deepak Jasani, head of retail research, HDFC Securities.