Is it time to buy the Indian midcaps – Update September 11, 2019

My 3rd note in the series. Has the midcap index bottomed?

My previous two notes on the topic –

Midcaps index has bounced from the recent lows and there are renewed talks of the index bottoming out. Consensus believes that the correction, which started in January 2018 maybe ending and going forward the midcap index would bounce back sharply and start outperforming the largecap index. Reasons for this belief include:

  • Reversal of the FPI tax surcharge – levied in the budget, the government finally reversed it on August 23, 2019.
  • Hopes for continued economic revivial measures – markets in general are optimistic that the government would continue to announce significant fiscal and monetary boosts to revive the economy.
  • Attractive valuations – Forward PE (Price to earnings ratio) for midcap index at 12-13x seems attractive compared with the historical benchmarks

The biggest positive for now seems to be – Government’s stance has changed from denial to acceptance…

and when one accepts, the action is bound to happen !

However, does that mean we are out of the woods…. Let’s check some key factors…
1. Economically, where are we now?
The situation was concerning before and continues to remain so. I don’t think the needle has moved much either ways.

What has changed is ‘increased awareness and wider acceptance’. However, due to the increased media coverage, it is currently working against us, by further denting the overall sentiments. SENTIMENTS, my regular readers would relate, is the single most important reason that I attribute the current slowdown to.

As mentioned before, the good thing is government is listening. There is a continued communication between Finance Ministry, Industry and press. Hopefully, we should see some key announcements soon. However, impact of any economic revival would entail time – unless government announces something that changes the consumer sentiment very quickly. What can that be? Something that significantly increases the disposable money available with consumers, e.g., revival of real estate, wherein significant money is stuck…

However, even if no significant announcements are made, I am not overly pessimisstic about the economy. This is based on my general interactions with few businesses across sectors – mood is of caution and not pessimism. Yes, auto numbers continue to be very bad but then it’s discretionary in nature and can move in tandem with the overall sentiments.

2. FII and DII flows
We continue to see relentless selling by FIIs, even after the FM reversed the tax surcharge. This is baffling to many and no one knows the reason…period. We can only hope that the situation reverses soon.

Good thing is that so far domestic money has countered the FII impact reasonably well and on month on month basis, MF inflows continue to be encouraging.

A significant reversal of fortunes for midcaps would need both FII and DII to turn positive, which can happen over short periods but personally I don’t expect over sustained periods, atleast for now…

3. Kashmir issue
Recently, the government took some significant decisions with regard to the State of Jammu and Kashmir – revocation of Articles 370 and 35A and conversion of the state into two Union Territories.

I continue to struggle to factor this in my investment strategy. The fact remains that the decision is very recent, of significance and highly sensitive.

4. Global factors
Globally the situation continues to be far from stable. We have global growth concerns, Hong Kong protests, Brexit uncertainty and US getting into an election year with a very unpredictable sitting US president.

Irrespective of how we are doing domestically, we cannot move in isolation to the global markets – especially if the latter were to correct significantly.

5. Are midcaps deep value buys?
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 !

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

It’s sometimes surprising, how charts follow a scripted path. Presently, I am talking about convergence between largecaps and midcaps, and midcaps facing significant resistance near trendlines !

Conclusion – Considering everything, I continue to tread with caution though with more optimism than before. Irrespective of how market behaves from hereon, it would provide sufficient opportunities to enter. Besides, I don’t follow the strategy of trying to pick the bottoms anymore !

Disclaimer: Above are my personal opinions and not any recommendation. The reader should do his own research before making any investment. 

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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

You are right Sir that there is no sign of revival style in economy but as You know markets starts climbing much before the Economy does. Also have seen CV stocks triple before they start giving positive monthly sales growth nos in the previous cycles, not sure about whether we are already in that upturn or we have to wait for it still.

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