In 2018, 75 percent stocks in the BSE Midcap index delivered negative returns

It looks like the age-old saying, ‘sell in May and go away’ might be coming true not just for May but for 2018. The BSE Midcap index and BSE Smallcap index has plunged over 12 percent and 14 percent in 2018, respectively.

Both small and midcap indices produced many multi-bagger stocks in 2017 but the New Year has started with its own set of challenges for the broader market. Market experts advise investors to stick to quality and limit their small and midcap exposure to 20-30 percent of their portfolio.

In 2018, 75 percent stocks in the BSE Midcap index delivered negative returns. These include - Vakrangee (down 87 percent), Reliance Communications (down 57 percent), Adani Power (down 49 percent), Bank of India (down 45 percent) and Union Bank of India (down 42 percent).

The remaining stocks that managed to buck the trend include: Mphasis (up 54 percent), L&T Infotech (up 37 percent), Gruh Finance (up 34 percent), Ashok Leyland (up 24 percent) and Biocon (up 20 percent).

There are plenty of factors which have plagued the midcap space: high valuations, falling rupee versus the dollar, persistent selling by foreign investors, earnings failing to pick up as well as classification of mutual funds by the Securities and Exchange Board of India (Sebi) led to some shuffle in mutual fund portfolios.

“The midcap and smallcap indices are quoting at an astronomically high price-to-earnings (P/E) ratio. On a trailing basis, the midcap index was at 50 times and smallcap index was at 100 times, which is not sustainable in a difficult macro environment,” Hemang Jani, Head - Advisory, Sharekhan by BNP Paribas told Moneycontrol.

He was quick to add that investors need to maintain an exposure limit to avoid shocks to the portfolio. “Exposure of 20-30 percent is considered reasonable. We have to remember that there could be better performing companies within midcap/smallcap space where one can hold or add stocks during the volatile phase.”

Jani feels it makes sense for investors to exit not-performing companies and move into ones with better performance and quality management.

The bull market in midcaps started after 2014 when the Narendra Modi government took charge at the Centre. Since then, the broader market saw massive inflows into local mutual fund portfolios. Most funds inflows were diverted into mid- and smallcaps due to lack of largecap options.

A lot has changed since 2014 and the mid- and smallcap space seems to be losing momentum. “After 2014, the midcap-to-Nifty ratio broke out of a decade cycle downtrend on the back of investors chasing midcaps,” Elara Capital said in a report.

The brokerage advises investors to focus on largecaps from mid- and smallcaps. However, it was quick to add that bottom-fishing remains strong and hence one could see strong counter-rallies.

The story is similar in the smallcap space as 80 percent of stocks in the BSE Smallcap index posted negative return so far in 2018. These include: Gitanjali Gems (down 92 percent), Diamond Power (down 87 percent), Electrosteels Steels (down 81 percent), Orient Paper (down 75 percent) and SRS Real Infrastructure (down 80 percent).

If we look at the stocks which managed to outperform the index, only 20 percent bucked the trend. These include: Excel Industries (up 102 percent), Nelco (up 77 percent), Firstsource Solutions (up 73 percent) and Mindtree (up 64 percent).

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