Small-Midcaps: Stock-specific Sizzle?

Stock specific actions i.e. momentum in small and midcaps so to say, are nothing new. This is the phenomenon that has been shaping market movement over past months, primarily driven by deluge of flows into domestic mutual funds. What is new is the expected acceleration of this phenomenon because of continued delay in earnings recovery in the top end and increased disenchantment of FIIs with Indian markets. This has caused lackluster movements in the top end of the market (large caps), while broader markets exhibit continued stock specific actions because of heightened domestic flows. For the first time ever, domestic flows surpassed FII flows by multiple times. To be precise, it is over 3+ times FII flows in this year (because of aggressive FII selling amid huge domestic buying over last three months). This, coupled with the fact that India macro is losing part of its luster on hardening crude and on weakening prospects for twin deficits (fiscal and current account), will strengthen this trend of stock specific actions further in the coming months.

As has been argued by this column for a while, the GST and DeMo impacts are transitory and will fade away sooner than later. That does not mean that the economy will break out of the range (6 to 7% range) any time soon, though it will be off its first quarter low of 5.7% soon on GST restocking and on low base effect in Q3. The break out to the 8%+ level can happen only if the investment demand recovers (capex cycle), prospect of which has improved though on the recent bank recapitalization move, one has to watch out closely the metrics of utilization and surplus capacity to sense the early signs of such a recovery. Until then, both economy and the markets are unlikely to break out of the range, while stock specific action will sizzle the small and midcap space. This, in a way means extended phase of time correction (with intermittent volatility of course) for top end of the markets, if not for the entire markets.

The key downside risk to the above prognosis is likely to come from potential acceleration in Fed action on monetary tightening. So far under Yellen’s chairmanship, market has been pricing-in a gradual and moderate tightening from Fed. Market will be watching closely on the new Fed chairman’s appointment for cues on the direction and for the pace of monetary tightening which in turn will dictate the global market’s trend.

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