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Small and midcap stocks not part of January celebrations on Dalal Street

MUMBAI: Benchmark indices have hit record highs in almost ev..

MUMBAI: Benchmark indices have hit record highs in almost every other trading session in January, but the broader market appears less optimistic. An ET study shows 67% of the BSE 500 constituents, or 337 stocks, declined in January as expensive valuations and worries over tighter stock taxation rules prompted investors to dump midcaps. The stocks that have fallen the most belong to debtladen firms, though investors are also showing aversion to companies with hazy earnings prospects.

Of BSE 500 stocks, seven have fallen 20-39%. These include Religare Enterprises, Reliance Naval and Engineering, Unitech, Reliance Power and Bombay Dyeing. While 67 stocks lost 10-20%, 128 fell 5-10%.

Market Nervous
"A combination of factors is possible for this. In some cases, valuations are finally catching up. In others, it could be profit booking because of fear of longterm capital gains tax on equity," said Nilesh Shah, chief executive officer at Kotak Mahindra Asset Management Company.

Dalal Street is nervous that the government could either extend the tenure for applicability of short-term capital gains tax or introduce a levy on long-term capital gains in the Budget. In January, Sensex gained 5.6% thanks to blue chips such as Reliance Industries, HDFC, Tata Consultancy Services and HDFC Bank. During the month, the BSE Midcap index declined 2.6% while the smallcap gauge slipped 2.7%. The BSE Midcap index is down 5.2% from the peak that it hit during the month, while the BSE Smallcap index is down 7.3%.

The selloff in mid- and smallcap shares did not impact sentiment because of the recordbreaking run in benchmark indices during the month, with the Nifty and Sensex crossing the key milestones of 11,000 and 36,000 points, respectively. On Wednesday, the BSE Sensex fell 0.2% to 35965.02 points. But the broader market saw bigger losses, with the BSE Midcap index sliding 1.3% to 17364.20 and the Smallcap index falling 0.83% to 18716.77.

One factor that worked against the broader market in January was that the rally was driven by global factors and buying by foreign investors — a trend that is more supportive of large-caps, said Bharat Iyer, head of India equity research at JPMorgan. Regulatory woes have also spoiled the over-year-long party in midcaps and smallcaps.

"On the domestic front, macro stresses have been building up, as reflected in the sharp spike in benchmark bond yields. Also, recent Sebi (Securities and Exchange Board of India) norms on classification of mutual fund schemes and the composition herein could potentially result in some selling pressure in overowned midcap names," said Iyer.

Sebi had issued a circular in October directing mutual funds to categorise equity schemes under large-caps, mid-caps and small-caps, depending on the market capitalisation of stocks that a scheme has invested in. Whether the valuation gap between the broader market and large-cap index widens further will hinge partly on the Budget.

Though mid- and small-cap shares have dropped, valuations remain rich. The premium in price to earnings (P/E) ratio of the BSE Midcap index to that of the Sensex has shrunk slightly, but is hovering near record levels. The premium, which widened to 22.79 on January 8, the highest on record, stood at 20.11as on Wednesday.

"In the last two years, midcaps have outperformed large-caps. If the market corrects, the fall is likely to be sharper in midcaps and smallcaps, especially since they are so expensive," said Jyotivardhan Jaipuria, founder, Veda Investment Managers.

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