Not much room left for rerating of smallcaps and midcaps: Nilesh Shah

There is not much room for rerating of smallcaps and midcaps in the current scenario, except for a few stocks, says Nilesh Shah, Managing Director of Kotak Mutual Fund. Edited excerpts from an interview:

How will the reopening trade apply to certain pockets like consumption? Do you have that kind of conviction in reopening this time?
The regional and rotational lockdowns in the second wave created far lesser disruption to economic activities as compared to the national lockdown in the first wave. It did impact economic activities but it did not impact as much as the first wave. In the first wave, we saw the GDP coming down by about 24 per cent. In this second wave, the GDP growth could still be positive or marginally negative.

From a ramp up point of view, clearly once the second wave started coming under control and opening up of the economy happened, activity levels started normalising pretty fast. Today in the month of June-end, the activity levels are above April levels. In the first wave, unemployment went from about 6 per cent to about 25 per cent. In the second wave, it went up but from 6 per cent to 13 per cent. Now it is back to a higher single digit. So whether we look at economic activities, which are now at April level, or unemployment, which did not rise as much as the first wave, and if you look at normalisation of economic activities, everything is pointing towards lesser disruption and faster normalisation. Does this mean that we do not have pain points in the economy? The answer undoubtedly is no. MSME sector, in our opinion, has been hit hard and will require some sort of nurturing and support.

Do you think that action in the broader market will continue? Do you see interest building up in some of the quality companies in the larger universe now vis-à-vis the index? How do you see the trend panning out?
This is one question which is dividing the market. Smallcaps have delivered double the return of largecaps in the last one-and-a-quarter year. Midcaps have delivered about 1.5 times returns of largecaps. The valuation gap between large, mid and small caps has narrowed down considerably. There is one set of market participants who believe that now largecaps will take the lead and the rally which we saw in small and midcaps will start getting consolidated.

On the other hand, there is a set of market participants who believe that even now quality midcaps and smallcaps will show better earnings growth and hence their valuations are not truly reflected in their growth potential. Now this is where we are seeing a division in the market. There is no clear view at this point of time.

We believe there will be a few small and midcap stocks where earnings growth could surprise the market. Hence, they will deliver better returns than largecaps. But if you look across the entire basket of small and midcaps, that looks difficult. The valuation in small and midcaps have got rerated pretty well in the last one-and-a-half year. At this point of time, we really do not have any preference over largecaps, midcaps or smallcaps. There is not much room for rerating of small and midcaps in the current scenario, except for a few stocks.

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