Couple of days ago, a friend forwarded the following chart which
suggests that small cap stocks may be offering once in many year opportunity,
as the value of small cap index compared to the Sensex has fallen to the point
from where this index has rebounded sharply on each of the previous three
occassions since 2003, when the BSE Small Cap Index was first launched.
If the strategy notes for the year 2020 published by various
market participants are any indication, a significant majority of the market
participants appear inclined towards this view.
Since some people have asked, I would like to share my view on
this aspect. In my view, this is a purely academic exercise for three simple
reasons:
1. There is no mechanism
whereby an investor can directly invest in a Smallcap Index. To my knowledge
there is no ETF available on the Small Cap index. It is almost impossible for
an investor to buy all 60 stocks in BSE Small Cap Index or 100 Stocks in NSE
Small Cap 100 Index to replicate these indices in his/her portfolio.
2. The elimination rate in
small cap space is usually very high. A large number of Small Caps that
performed very well during a particular market cycle, are less likely to repeat
their performance in the next cycle. In fact, most "good quality"
small cap stocks migrate to mid cap or large cap category in each market cycle,
whereas a large number of small caps become micro cap or penny stocks.
If someone had invested in a basket of top small cap stocks in
2009 or 2014, there are almost 75% chance that stocks in that basket have
either moved higher to mid or large cap or become useless losing 70-99% of
their value. IN the next market cycle, wherever it happens, in likelihood we
shall see a new set of "outperformers" and "multibaggers".
3. In 2001 and again
2013-14 the ratio become worse after hitting the rebound line. If one invested
at the first hit, there are chances that he lost 25-30% before the rebound
actually happened.
It is also pertinent to note that, while the Small cap to Sensex
ratio has hit the rebound line, the Midcap to Sensex ratio is still some
distance away.
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