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Smallcaps  surge in 2021 as investors shrug  off virus  risk

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Shares of smallcap companies have stayed resilient even as the second wave of covid has disrupted business operations, with more states imposing lockdown-like curbs to restrict mobility. With small and midcap stocks outperforming benchmarks, investors seem to be shifting to the riskier segment. However, in broad market corrections, smallcaps tend to fall more than large-caps because of low floating stock.

The BSE Smallcap index has outpaced benchmarks by a wide margin this year. Year to date, the BSE Smallcap index has surged 23%, and BSE Midcap gained 15%, while Sensex and Nifty were up 3% and 6%, respectively.

Even in April, when India reported the highest rise in covid cases and states imposed lockdowns amid a health crisis, the BSE Smallcap index jumped 5%, whereas Sensex and Nifty fell, and BSE Midcap was barely up 1%.

The BSE Smallcap index hit a record high of 22,360.13 on Friday.

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The BSE Smallcap index has outpaced benchmarks by a wide margin this year

Ample liquidity and market optimism that the impact of the second covid wave will not be as harsh as the outbreak in March last year are fuelling the rise, analysts said. “Nifty and Sensex have been in consolidation since mid-January because of which liquidity found its way into midcap and smallcap segments. Also, with most largecaps fairly valued, value investors started moving down the market cap pyramid,” said Siddhartha Bhamre, an analyst at Incred Research Services Pvt. Ltd.

He added that from November 2020 till the end of February 2021, it has been a linear progression for midcap and smallcap indices, but now volatility has entered these segments.

“To add, in midcap and smallcap rally, drivers keep changing and, eventually, it boils down to stock selection art. So, even if there seem to be near-term hurdles due to macro factors, there will be names in this segment that will keep surprising risk-averse participants,” Bhamre added.

Smaller stocks are considered to be more in sync with the economy and typically see sell-off pressure at the beginning of an economic downturn.

However, even as economists and rating agencies have started to gradually slash India’s gross domestic product (GDP) target for FY22, investors have stayed hooked to smallcap stocks. For instance, S&P Global Ratings on Wednesday cut India’s GDP growth forecast for the current fiscal to 9.8% from 11% set in March, stating the second wave may derail the budding recovery in the economy and credit conditions.

“While it’s true that smallcaps fall more when there is a downturn in the economy, the base case scenario as of now does not call for a major contraction in economic activities, unlike what we saw in the first wave. As markets are not expecting any major disruptions to the economy, there has been no panic selling,” said Jyoti Roy, deputy vice-president – equity strategist, Angel Broking Ltd.

Moreover, FII holdings are also concentrated in larger firms and, therefore, FII selling has a larger impact on frontline largecaps rather than midcaps and smallcaps. Also, smallcap indices have much lower weightage in banking, financial services and insurance (BFSI) sector, which has been among the worst hit, Roy added.

In April, there was a net FII outflow of $1.5 billion after six consecutive months of inflows. Domestic institutions were net buyers for the second straight month at 11,089 crore. Despite the rally, analysts believe both small and midcap stocks will continue to sustain growth.

According to Incred’s Bhamre, largecaps “take the driver’s seat during market corrections, and until meaningful corrections happen in the largecap space, we should not expect big selling in mid and small segments either”.

Roy of Angel Broking expects the smallcap rally to continue but sees an increase in volatility in case there is a continuous increase in new cases, and it becomes clear that the lockdowns will extend well into the fiscal second quarter, thus leading to downgrades in GDP growth and earnings estimates for FY22.

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