Markets

Is it time to buy the Indian midcaps – Update August 6, 2019

Since my 1st note on the subject in June 2019, midcap index has further corrected by 14%. Does it make sense now?

Click here for my June 2019 post on the subject

For quick reference, key points highlighted in June 2019 post were –

  1. Technically, Midcap index needs to consolidate much farther and longer before breaking out again.
  2. Midcaps by nature need strong favorable sentiments for outperformance. The sentiments both domestic and international continue to be cautious.

What has prompted me to relook at the subject …. and so soon?

Over the last couple of months, Indian investors have been taken to the cleaners. There has been a sort of bloodbath in the stock markets and in a short span of two months, midcap index has declined by almost 14% (nifty50 by 9%).

Midcap index currently is same as what it was 3 years back – ‘Nil’ returns in 3 years

From the highs of January 2018, midcap is down by almost 30%

Leaving aside the significant correction at the index level, the situation is worse at the company level. Many small and midcap companies have fallen by as much as 70-80% from the top – and these include some ‘optically’ strong companies.

Consequently, a point of discussion in every forum is – are midcaps oversold and is this the time to buy?

Here it is important to list down key factors that have led to the correction in the last two months –
  • Super rich tax (high surcharge) announced in the budget with it’s associated implications for the Foreign Portfolio Investors (FPI);
  • Increased awareness and wider acceptance of India’s weakening economic fundamentals – auto, realty, NBFCs, banks, consumer companies continues to display weakness. Autos especially, have worsened and significantly dampened the overall sentiments.

The same pundits who were advocating buying midcaps in June 2019, now after a further 14% cut, have gone extreme and started calling the dooms day.

My humble submissions for you to note
1. Economically, is situation worse now than what it was in June 2019 – I believe “Not”
The situation was concerning then and continues to remain so. I don’t think the needle has moved much for worse. As mentioned before, what has changed is ‘increased awareness and wider acceptance’. This doesn’t change on ground economic situation in a significant way.

I agree, in auto sector the monthly sales numbers trend has been worrisome. However, in other sectors the situation as further demonstrated by quarterly results, continues to be of caution and not pessimism. Auto demand being discretionary in nature can be volatile over short periods.

2. Poor sentiments – main reason
This is one factor, which I believe has been the main culprit and rather than improving has taken a further significant hit over the last two months. If not resolved soon, can possibly lead economy into a tailspin.

I had written about this topic in detail in my pre-budget expectations note. Anyone, interested can please refer the same.

3. Will government act – surely and I expect very soon
Government is aware about the economic situation as well as the FPI issue. It’s bound to act and act soon. In fact, as I write this, the markets are up in anticipation based on the announcements by the Hon’ble FM yesterday.

However, whether FM can announce something that would change the character of the market overnight. I expect not. Impact of measures on economic revival would entail time.

The immediate event to watch is RBI credit policy tomorrow, wherein I believe RBI springs some surprises.

Besides, FPI issue resolution can stop FII outflows and can potentially reverse the trend. However, I expect DIIs to continue take the reverse position and hence a significant trend reversal is unlikely.

Short term upticks are likely but secular upturn is unlikely....anytime soon Click to Tweet
4. Are midcaps deep value buys – selectively yes
Midcap index is currently trading at a one year forward P/E of 12-13x. This on the face seems attractive and becomes extra enticing when one looks at the current prices of many stocks vis-à-vis their all time highs.

However, as before, I would repeat the caution here. Yes, there are many companies that seem to be offering intrinsically good value. However, one needs to be extremely careful and choosy. We are still long way off from euphoric times !

5. Technically, the trend continues to be negative
Like my previous note, please checkout the following three charts – long term, medium term and short term, comparing midcap index with nifty50.

Conclusion – I see no major reason for significant change in the outlook vis-à-vis my note of June 2019. I continue to tread with caution.

One point which I continue to keep a close watch upon – US markets – Any significant selloff in the US markets is bound to impact Indian markets negatively irrespective of what we are doing ourselves.

Ideal scenario for us – improved domestic fundamentals especially overall sentiment, FPI resolution, along with gradual selloff (or consolidation) in US markets leading to shifting of money from there to here as opposed to panic sell off in US markets leading to shifting of global liquidity towards safe assets.

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About the author

Nitin Jain

A finance professional with around 20 years of investing experience in Indian markets both on buy and sell side, equity and debt, private and public with some of the best organizations globally including Goldman Sachs, ICICI Group, ICRA and others. He is a All India Silver Medalist CA by qualification.

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Jatin Vora

Very nice and informative article Sir. keep it up.

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