Small stocks sparkle amid pandemic gloom; likely to shine in 2021 too

Small stocks made a dashing comeback in 2020 after delivering negative returns in the last two years as increased retail investor participation in pandemic times saw small cap index surging up to 31 per cent and outperforming the bigger benchmark gauge.

This year turned out to be eventful for the equity market, witnessing bearish and bullish sentiments at different points of time. While the initial part of COVID-ravaged 2020 saw the bears in full force amid concerns related to the pandemic and lockdowns hurting economic activities, bulls made a comeback towards the latter half of the year.

As the market swayed with many lows as well as highs, small and mid cap indices emerged as markets favourites in 2020.

"During March lows, many mid and small cap companies were trading at extremely attractive valuations as compared to large cap stocks. Hence, valuations coupled with ample liquidity in the markets took the mid and small cap stocks to higher levels.

"Also, in the last 6-8 months retail participation has increased multi-fold due to which we have seen huge traction in these stocks along with the large cap stocks," Hemang Jani, Head and Equity Strategist at Motilal Oswal Financial Services (Broking & Distribution) said.

Till December 29 this year, the BSE midcap index has jumped 2,842.99 points or 18.99 per cent, while gains have been sharper for the small cap which zoomed 4,268.3 points or 31.15 per cent.

In comparision, the BSE benchmark Sensex has clocked 6,359.34 points or 15.41 per cent gain so far this year.

March turned out be a nightmare for the domestic stock market, with the benchmark Sensex plunging a whopping 8,828.8 points or 23 per cent during the month as concerns related to the impact of the coronavirus pandemic on the economy rattled investor sentiments.

Rusmik Oza, Executive Vice President and Head of Fundamental Research at Kotak Securities said the reason for the outperformance of mid cap and small cap indices this year is due to their under performance in the previous two calendar years.

The mid cap index dropped to its one-year low of 9,555.24 on March 24 before surging to its 52-week high of 18,017.56 on December 17.

In a similar fashion, the small cap index crashed to an all-time low of 8,622.24 on March 24 but bounced back to scale a one-year high of 18,089.16 on December 29.

During the year, the benchmark 30-share Sensex touched its one-year low of 25,638.9 on March 24. Recovering the lost ground, the key index soared to a record high of 47,807.85 during the day on December 30.

"This year retail participation has gone up tremendously in the market due to the lockdown and also beaten down market levels. Retail investors typically tend to avoid larger names and dabble in smaller or mid-sized companies because of limited capital and desire to own more number of shares.

"In the course of the year when one looked at the charts of most mid and small cap companies they were all beaten down severely from their peaks of 2018 which provided very good upside potential in most of them," Oza said.

He also noted that opening of the economy post lockdown, improvement in lead indicators, positive FPI flows into large caps and better earnings outlook helped mid and small caps to catch up for the previous two years' underperformance.

The year 2019 belonged to frontline companies and small stocks had failed to attract investors' interest. In a reflection of bearish trend last year, BSE midcap index fell by 3 per cent while losses were even sharper for the small cap index at about 7 per cent. At the same time, Sensex managed to overshadow its smaller peers by climbing 14.37 per cent.

Small and mid cap stocks had faced a rough ride in 2018 as well, slumping as much as 23.52 per cent.

"The small cap index is always far more volatile than mid and large cap. Since new retail investors prefer small caps, frenzied retail investor buying can push the small cap index too high in a short period. This happened in 2017 when the small cap index shot up by around 52 per cent.

"But irrational valuations cannot sustain and when the market corrects, as they did in 2018, small caps crashed making valuations attractive. This year, after the massive market crash in end-March, markets recovered smartly," V K Vijayakumar, Chief investment Strategist at Geojit Financial Services, said.

He also pointed out that in the last two months of the calendar year, mid and small caps have been catching up. Largely, small caps are compensating for their poor performance of 2018 and 2019, he added.

Lifting of lockdown curbs, the government's efforts to restore economic activity, record foreign fund inflows, progress on vaccination roll out globally and pandemic relief package in the US were some of the positive factors that helped markets recover after the massive correction in March.

According to an year end note from Motilal Oswal Broking & Distribution, equity markets had a historical journey in 2020, as it marked a year of huge volatility, unpredictability, pessimism, divergence and optimism.

"The markets touched an all-time high in January 2020 and then hit a 3-year low in March as COVID-19 pandemic gripped the whole world, becoming one of the biggest threats to the worldwide economy.

"Unlocking of the economy since June has led to significant recovery in various macro, micro and high frequency data points, resulting in equity markets surpassing its previous lifetime high once again. Further, strong FII inflows, good corporate earnings season, and encouraging trends from the festive season, suggests that the demand recovery is likely to continue," as per the note.

The performance in small caps has been across the board. This year's rally has been broad-based, with participation from stocks across all sectors. Mid cap companies from broader sectors like IT services, pharmaceuticals, metals and mining have done well due to the rally in bigger peers, Oza said.

According to market analysts, smaller stocks are generally bought by local investors while overseas investors focus on bluechips or large firms.

"Many sectors like pharma, IT, agro chemicals, metals, banking and financials, and cement have done well in the last 6-8 months from the lows of March 2020. Many stocks from these sectors have moved up in the range of 50 per cent to 200 per cent in this time frame," Jani said.

The mid cap index tracks companies with a market value that is, on an average, one-fifth of bluechips while small cap firms are almost a tenth of that.

On the the road ahead for small cap and mid cap indices, Jani said that mid and small cap companies across sectors that fit into few criteria's like management quality, financial track record, and earnings visibility would continue to attract investors.

"Q3 numbers for the corporates will be watched closely going forward and they will decide further trend of these stocks in coming months. If economic revival is strong and retail participation is on a higher side, mid cap indices may continue to outperform the larger indices in the next year too. IPO pipeline will also be a factor to watch out for retail participation," he added.