Small stocks have lagged behind the equity benchmark Sensex in 2022-23, falling nearly 6 per cent amid a host of negative factors like higher interest rate regime, high inflation and the Russian-Ukraine war. According to market analysts, it was a tumultuous year for the Indian equity market.
The Russian-Ukraine war made the first quarter of the Indian equity market particularly difficult, but the second and third quarters witnessed a respectable rebound, they noted. Headwinds such as high inflation, the Russia-Ukraine war and higher interest rates hit investors' appetite for small stocks.
With just one day of trading left in the current fiscal, the BSE smallcap gauge has fallen by 1,616.93 points or 5.73 per cent so far in 2022-23. The midcap index is down 270.29 points or 1.12 per cent in the 2022-23 financial year. In comparison, the BSE Sensex has declined 608.42 points or 1.03 per cent.
"Many factors contributed to the underperformance of the Indian stock market in FY23. The Indian market performed remarkably well in FY21 and FY22, as both the Nifty and Sensex produced double-digit returns. When the Indian stock market performs strongly for two years in a row, profit booking is inevitable in the third year. In FY23, we experienced headwinds due to the Russia-Ukraine war that negatively impacted market sentiment.
"In addition, central banks around the world began to hike interest rates to curb inflation. This compelled investors to switch from the risk-on to the risk-off strategy," said Sunil Damania, Chief Investment Officer at equity advisor MarketsMojo. The BSE smallcap index jumped 7,566.32 points or 36.64 per cent in 2021-22 fiscal, and the midcap surged 3,926.66 points or 19.45 per cent.
In comparison, the Sensex ended 2021-22 with a gain of 9,059.36 points or 18.29 per cent. "We have observed in the past that when interest rates start rising, mid and small-caps tend to underperform. Their ability to service higher borrowing cost is not as robust as large-caps," Damania said.
In FY21, the BSE smallcap index had zoomed 11,040.41 points or 114.89 per cent, while the midcap index jumped 9,611.38 points or 90.93 per cent. In comparison, the 30-share BSE benchmark had clocked 20,040.66 points or 68 per cent gain during 2020-21.
"The Indian equity market has had a flat-to-down year for FY23. The underperformance of the equity market was primarily caused by several causes, including global anxiety, particularly rising inflation, a significant increase in interest rates in the USA and later global financial troubles. We outperformed our global competitors in the prior fiscal year, which is another factor.
"Mid and smallcap companies suffer from greater inflation and higher borrowing costs since they are less able to transfer input prices and have higher borrowing costs when compared to major players," Santosh Meena, Head of Research, Swastika Investmart Ltd, said.
In an uncertain atmosphere, investors also seek protection and smallcap companies are viewed as riskier investments in the equity market, Meena said. The midcap index tracks companies with a market value that is, on average, one-fifth of blue chips, while smallcap firms are almost a tenth of that universe.
It was a tough year for the Indian equity market amid global uncertainties with the Ukraine-Russia war, Fed rate hikes, inflation and recession projections, Arvinder Singh Nanda, Senior Vice President, of Master Capital Services Ltd, said. "The underperformance has been attributed to a range of factors, including continuous Foreign Portfolio Investors (FPI) selling, reopening of the Chinese economy and sell-off in Adani Group stocks," Nanda added.
The 10 listed Adani Group companies have together lost significant market value following the US short-seller Hindenburg Research report on January 24. The BSE smallcap gauge fell to its 52-week low of 23,261.39 on June 20, 2022, and later reached its one-year peak of 30,185.95 on September 15, last year.
The BSE midcap index hit its 52-week low of 20,814.22 on June 20, 2022, and later bounced back to reach its one-year high of 26,440.81 on December 14 last year. The Sensex reached its all-time high of 63,583.07 on December 1, last year, after hitting its one-year low of 50,921.22 on June 17, 2022.
On the outlook for midcap and smallcap indices for the next fiscal, Meena said, since the environment is still uncertain, there is a chance that volatility may persist in the first quarter of FY24. But, as the market becomes more certain about when US interest rates will peak, the overall market will begin to trend upward.
"We expect interest rates to begin stabilising in FY24 and then decline. If this occurs, small and midcap stocks will begin to outperform. We are confident that the risk-on strategy will make a strong comeback in FY24. This will further boost demand for small and mid-cap stocks. While we did expect mid and small-caps to perform well in FY 2023, we anticipate a strong comeback in FY 2024," Damania added. According to market analysts, small stocks are generally bought by local investors, while overseas investors focus on blue chips or large firms.