Small-Caps, Mid-Caps: Too Hot to Handle?

What factors drive the exceptional rally in small-cap and mid-cap stocks? Broadly, there are two reasons why small caps have been able to hold their ground. The primary reason is that for the last four to six years, the domestic market has been driven by individual investors - they are SIP investors. And a good part of investor money is flowing into small-cap funds. So, if money is flowing into small-cap funds, it has to necessarily get invested there. That apart, many small-cap companies have been able to improve their performance. They have scaled up and grown. So, both investor enthusiasm, largely led by domestic investors, and rising earnings are driving this rally. Even when foreign investors have pulled out, it has been predominantly from large caps or larger mid caps. This does not hurt small caps as much. The resilience of small-cap funds, derived from this steady investor participation, is very significant. How sustainable is the rally in the current economic and market environment? While it may not be sustainable, markets are always like this. You'll have intermittent phases when they collapse or correct sharply. We haven't seen a meaningful collapse so far, but in the last four or five years, there have been intermittent corrections. If small-cap companies keep receiving money as they are now, some valuations may cross their justified limits. That's when one should start worrying. That said, the small-cap universe is very large. If 100 companies falter, all portfolios won't collapse. In contrast, in large caps, if five companies falter, the entire market can crumble. So, I'm hopeful. It may not turn out to be as bad as people expect, especially considering the steady flow of SIP money from individual investors. Suggested read: Investors riding the small-cap tiger's back What are t

This article was originally published on December 06, 2024.