Midcap Earnings - Q3FY09

Midcap Earnings - Q3FY09

Midcaps in flavour

Mid and small-cap shares remained in focus on Friday, as investors continued to mine the broader market in search of value bets. With the valuations of frontline shares perceived to be stretched, investors restricted activity in this segment to a few, resulting in equity benchmarks closing marginally lower in a listless trade on Friday.

The Sensex closed at 20,030.83, down 73.56 points, or 0.37%. Nifty ended at 6,047.70, down 10.4 points, or 0.17%. In the broader market, the small and mid-cap indices rose 1-2%. Gainers led losers at 2,082:830 on BSE, indicating that the bullish streak is intact. Analysts and fund managers said investors are lapping up mid- and small-cap shares because many of them trade at a discount in valuation to their frontline counterparts.

“Mid-caps are now trading at a 20-25% discount to large caps, the highest over the past 4 years. Therefore, the trend witnessed in November, where benchmark indices declined while the broader market indices outperformed, may continue for next few weeks,” Merrill Lynch said in a recent note.

Experts feel that the frontline shares, which constitute the benchmark indices, are unlikely to rally in the near term, unless foreign institutions return to India in a big way. The Sensex is trading at roughly 20 times the 2008-09 estimated earnings.

Many foreign institutions prefer to stick their bets to frontline shares due to higher liquidity and that
these companies are perceived to follow better corporate governance standards.

Foreign institutional investors (FIIs), according to provisional data on NSE, on Friday net sold Indian shares worth Rs 647.1 crore, while domestic financial institutions net bought to the tune of Rs 105.18 crore.

Since the US Federal rate cut on Tuesday, selling by foreign institutions have risen, while domestic institutional buying has been fading. So far this year, FIIs have net bought Indian shares worth Rs 70,421, according to Sebi data.

Elsewhere in Asia, markets extended losses on Friday, with Japan’s Nikkei and Topix indices falling close to a percentage each. Hong Kong’s Hang Seng dropped 0.6% and Singapore’s Straits Times ended roughly 0.4% lower.
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Back home, the inflation index rose to a three-month high mainly due to the statistical effect of a lower base. The whole price index (WPI) rose to 3.75%, in the week ended December 1 from the same period last year, up from the previous week’s 3.01%.

Market View

We are likely to see some mid-cap out-performance, particularly once the January results give local investors an idea of the story for FY08. Growth expectations are currently around 15 per cent for FY08 on the previous year. However, in the mid-cap space this may be far higher. FIIs may also start to approach saturation of investible limits (due to foreign investment limits) in the large-cap space, which will lead to filtering down into more mid-cap names.

The risk to this situation is the 1 lakh crore IPO pipeline, which may absorb some of the FII demand and deflect from a focus on mid-caps. Additionally, the liquidity issues in mid-caps continue to be an issue for large investors. Finally, in a market like India, momentum tends to take hold at times and we may see further blow-out in large-cap premiums before we see mean reversion take place. If one were to step out from the current trend favouring large-caps and set the vision further, mid-caps represent the opportunity in that space.

OptiMix

Indeed, it seems quite logical that if the world's economies are increasingly intertwined and interdependent they will become less dependent on the United States. From a structural perspective we even feel that fundamental long-term strategies should increasingly be adapted to this inevitable trend. Of course, the extent to which the rest of the world's economies "decouple" from the United States will depend on how much they are "desynchronised" from the US economic cycle and on other specific factors that are endogenous to the various pieces of the global macroeconomic puzzle. No doubt that emerging Asia is still the key piece to this puzzle. This currently seems to be the main concern of market observers.

BNP Paribas Asset Management

Emerging markets (EM) has historically been vulnerable to deteriorating economic and financial conditions in the United States and other developed countries. Slower growth, tighter liquidity, and heightened risk aversion in mature markets generally mean lower commodity prices, less capital flows, and higher interest rates for EM borrowers — conditions that helped produce some spectacular financial crises in the past dozen years. Not a pretty picture, and one that begs the question of what lies around the corner.

Given this backdrop, it is interesting that 2007 growth estimates for emerging market economies continue to be robust, suggesting a potential divergence this time for EM. Certainly the nature of the slowdown (hard vs. soft) in the US is critical to the performance of the EM economies and will shape expectations for EM growth and the performance of the asset class. But fundamental, endogenous changes in the emerging countries suggest EM is far better equipped to deal with a G-3 slowdown in the current cycle than in the past.

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