It is time to tilt towards large cap stocks

For the domestic stock markets, last one year has been quite unusual. Several themes have played out as against a normal practice of just one or two themes playing out once in three or four years in the Indian secondary markets. This time, we have seen a thematic rise in the stocks of tyres, sugar, NBFCs, textiles, auto components, infrastructure, etc. Mostly small and midcap stocks have participated in these thematic rallies.

Consequent to these successful themes, the market cap of small and low-end of mid-cap stocks - represented by the gap between the market caps of BSE 500 (which mostly represent large cap and large mid-cap stocks) and all BSE listed stocks - has risen by 55% to Rs 7.85 lakh crore in September 2016 as compared to Rs 5.05 lakh crore in September 2015. During the last one year, the market cap of BSE 500 has gone up only by 14%.

The market cap of this segment (small and low-end of midcap stocks) earlier also has shown a similar peak - It spiked to Rs 7.44 lakh crore in February 2015. However, this segment couldn't hold on to the wealth created - they crashed over 30% by September 2015. Once again, the market cap of this segment has peaked to Rs 7.85 lakh crore. The issue now is whether this second spike in these small and mid-cap stocks can hold on and consolidate or once again slip down quite badly.

The chances are quite that this segment of small and mid-cap stocks could correct substantially once again in the second half of FY2017 (October 2016 – March 2017). First of all, many micro and small cap stocks have already become solid multi-baggers. Secondly, even the loss-making companies and also companies with highly stressful balance-sheets have seen their stocks emerging as multi-baggers. Thirdly, in the last 10 years, the large cap index has outperformed both small cap and mid cap indices almost every alternate year. Finally, there is no valuation comfort even in many profit-making stocks in this segment. Valuations are at peak for many small and mid cap stocks in the sectors like auto-component, NBFCs, sugar, infrastructure, etc.

Thus, this is the time to tilt towards large cap stocks, specifically to ones which offer some valuation comfort on a relative basis. Of course, the investors can stay invested in the small and mid-cap stocks which have got appealing valuation along with strong balance-sheet and good management quality. Otherwise, the chances of current notional wealth created in the equity portfolios primarily with help of small and mid cap stocks may simply evaporate.