Mid- and small-cap stock indices not yet out of the woods, say analysts

The proposal to increase public float, hike income tax surcharge, move to tax share buybacks and lack of stimulus to shore up economic growth has hurt investor sentiment

Mid- and small-cap stock indices have underperformed large-caps so far this year, and also since the Union Budget on Friday. Analysts say there could be more pain in store for the broader markets.

The proposal to increase public float and hike income tax surcharge, which will not just be applicable to high net worth individuals (HNIs) but also to foreign portfolio investments (FPIs), has hurt investor sentiment. Besides, the move to tax share buybacks and lack of stimulus to shore up economic growth had added to investor woes.

Analysts say the markets will continue to remain under pressure, especially the mid-and small-cap segments, till there is clarity on these proposals. Also, corporate earnings will also play a big role in shaping market direction going ahead amid subdued economic growth.

“While demand for equity by institutional investors is highly concentrated in about 15 large-cap stocks, liquidity in the hands of individual investors has almost dried up due to huge wealth erosion in the broader markets. Therefore, any compulsion to fulfil this limit within the next two years could lead to supply of nearly Rs 4 trillion worth of equities in the market, which could possibly extend the weakness in the broader markets for the next two years,” said G Chokkalingam, founder and managing director at Equinomics Research.

So far in calendar year 2019 (CY19), mid-cap and small-cap indices have slipped 6 per cent each on liquidity issues and ratings downgrade of companies that featuring in these indices. In comparison, the BSE Sensex rallied 7 per cent during the period.

Among individual stocks, Bank of India, Canara Bank, Union Bank of India and Indian Bank from the state-owned lenders lost over 8 per cent each on Tuesday, after Punjab National Bank reported a fraud of Rs 3,805 crore by Bhushan Power & Steel. Analysts at Bank of America Merrill Lynch have given a thumbs-down to the Budget proposals and expect the indices to move in line with their emerging market peers, going ahead.

For the end of December 2019, they have a Nifty50 target of 11,300 – down nearly 2.2 per cent from the current levels.

“This Budget is not the ‘catalyst’ stock markets were hoping for. Little is expected to happen top down in India for the next several months. MSCI India should move in line with emerging markets. Unless growth improves, the broader market will likely remain weak, given the high valuations and poor earnings. The government’s attempts to raise revenues will likely remain an overhang on all PSU stocks. We prefer financials, IT and industrials,” said Sanjay Mookim, India equity strategist at Bank of America Merrill Lynch, in a post-Budget note.