If large corporates have poor results, the MSME sector has mounting defaults, and the government is cash-strapped and unable to increase expenditure, it is hard to see how the economy could maintain growth momentum. However, the stock market continues to rise, on the back of strong FPI (foreign portfolio investor) buying and steady inflows from retail investors.
The FPIs brought in over Rs 20,000 crore in November (until November 26) and the Sensex and Nifty have just hit new highs. However, the Karvy scam could be a dampener. It depends on the dimensions of the misuse of client assets. There are chances that Sebi’s actions to stop this misuse may trigger either major selloffs, or large-scale defaults. Neither might happen, of course, but this is a slow-burn situation. It could escalate.
Given a stock market trading at all-time highs, we would expect analyst coverage of stocks to also be at all-time highs. However, that’s not the case. A Bloomberg report indicates that analysts are reducing coverage of even the top 500 stocks. The Bloomberg data indicates that over a third of the BSE 500 have seen a reduction in the number of analysts covering the stock.
Analysts generally drop coverage when they can’t easily make earnings projections, or when there has been a clear deterioration in the fundamentals. As many as 48 companies in the BSE 500 universe reported losses in 2018-19.
The NBFC sector, telecom and other capital-intensive sectors have seen this reduction in coverage. Some of the big names affected are Indiabulls Housing, Vodafone Idea, Power Grid Corporation, Dewan Housing, YES Bank, JSW Energy, etc.
In general, the move has been narrow. A third of the Sensex 30 — ten stocks — have contributed over 90 per cent of the incremental gains in the past two months, since the corporate tax cut was announced. The midcaps and small caps have also moved up but less than the Sensex/Nifty. The midcap and small-cap indices are trending well below their all-time highs. Midcaps and small caps have also seen a decline in valuations, from average PEs of 40-plus a year ago, to below 30 now.
Valuations are not cheap in smaller stocks by any means. But they are lower than in large caps. Assuming that the rally continues, at some stage institutional investors will start looking at midcaps and small caps because of the valuation differential: Large caps will be too expensive for comfort and midcaps and small caps will start to look attractive.
Long-term investors should consider moving into smaller stocks now in anticipation of such a shift in institutional attitude. Rather than trying to pick stocks, it makes sense to build a diversified portfolio by exposure across midcap and small caps funds. There are several small-cap funds, for instance, that have consistently returned over 14 per cent compounded over the past five years.
But most of those funds also have negative returns in 2019-20. Indeed, most small cap and mid-cap funds have negative or low returns in 2018-19 as well. That pattern of losses could change, with a reversion to the long-term return.