The fall in the markets over the past month has raised an interesting debate. The debate surrounds the relative outperformance between largecap, midcap, and smallcap stocks.
This correction has seen persistent FII selling and the effect has been more visible in largecap stocks. When there is heavy, persistent selling in liquid largecap stocks, it becomes virtually impossible to cushion the fall in stock prices. The market simply reflects the demand supply gap and prices decline without adequate buying support. That may not be the case in relatively illiquid smallcap stocks where existing holders of individual stocks are able to buy adequate volumes and effectively cushion the fall in stock prices. Midcap is a category which is seeing mixed trends and we are yet to really see heavy selling.
Investors are keenly watching the relative performance to validate their specific preferences. Those who swear by smallcap stocks have a tendency to justify their preference by questioning the fall in largecap. “How can you call largecap stocks a safe haven? After all, they are also falling just as much as smallcap stocks if not more.” The market has its own way of selling down parts which are expensive.
Poor quarterly showing, unimpressive guidance and change in management commentary are happening more in largecap stocks. Larger companies have a greater need to forewarn investors, reset expectations and ensure transparency. The disclosure of bad news in smaller companies is relatively slower and their expectation setting is not as clear. Shareholders in smallcaps do not react as strongly, liquidity in these stocks is relatively less, and the prevalence of heavy selling is not as visible. The dips are also getting persistently bought in smaller companies by domestic investors. These factors are clearly giving us a sense of greater resilience in smallcap and midcap companies. But, this resilience will get tested if the headline indices correct further and the domestic liquidity gets absorbed fully.
The demand supply reset in domestic flows is gradually happening and will drive future trends in all parts of the market. There is also the prospect of change in direction of FII flows towards the end of the calendar year. The jury is still out as we face the prospect of fast paced changes in global and domestic flows.
Investors must maintain a cautious stance and remain steadfastly valuation centric in investment choices. Incremental monies must be very specifically targeted towards individual stocks and their valuation must be the decision driver.