Nifty: Small Caps vs Large Caps

Focusing back to Indian Equity markets!

The interplay between small cap and large cap has been very interesting back home, compared to global benchmarks. For last couple of years, S&P 500 and Russell 2000 more or less matched each others performance. In late 2013/ Early 2014 the small cap index outperformed, which is now reversed by a relative under-performance. Compare this to India. Ever since the financial crisis, the market recovery has been led by the large caps. Small caps (or mid caps) consistently under-performed, except since last June. The election saw a large out-performance by the small caps, but otherwise it has been pretty much dull. Small caps premiums has been in fact negative.

We take a look at the financials to see if there is any clue there. Below the aggregated balance sheet for Nifty 50 stocks, vs. Nifty Mid cap 50*

And here are the corresponding PnL figures*

* All data from Bloomberg as they report. I think more or less the trend is captured here.

As we can see, one large issue with the small cap balance sheet is in general total indebtedness. Since 2007, both the large caps and small caps companies increased their sales 2.3x, with an increase in balance sheet in the 3.44x/3.42x range. However while for Nifty companies it has been funded 70% by non-current liabilities, for Nifty Mid cap 50, the figure is at 80%. Both not great, but mid cap definitely worse. On top, the figures for small caps were worse to begin with. So the current levels look far from comforting from investors' point of view.

On the other hand, as far as the standard valuation parameters are concerned, on both revenue and balance sheet related metrics (like price-to-sales or P/E pr P/B) large caps are slightly overvalued (relative to historical spreads).

So overall it is not a straight forward call. Small caps are undervalued, but not by much as they were before mid 2014. At the same time, the overall sector balance sheet looks vulnerable to any interest rates shock. The question is if that valuation compensates for the leverage risks. Given the current outlook, probably this will tilt in the favor of small caps and mid caps over all. But not without a constant watch. I will definitely avoid any adventure in this space.

2014 H1: Top 5 Pain Trade

#1. Short Rates: USD, GBP (USD shown below)

#2. Short JPY vs USD: (and Long NKY)

#3. Flattener: in USD and in GBP (USD shown below, see short ED + notes vs long in long bonds)

#4: Long CNY Carry

#5 Short EM

And now after the ECB, we are back to carry trades

NIFTY: Great Expectations?

Here is a fantastic background for India 2014, more so for the uninitiated! (Do click)

And now the questions is how much juice left in this rally and which sectors are really overheated. Below a snapshot of the relative performance of different sectors vis-a-vis the benchmark (NIFTY) index. As you can see the rally that started late last august once quite contained. But the pre-election rally (a possibility I noted before) has been, well, fantastic. With all the usual suspects racing away - only Energy, Pharma, FMCG and IT still lagging.

The question is what now. Obviously the pattern of the rally since March shows a lot have been on expectation of a radical shift in policy after the elections are done with. PSU banks, Real Estate, Financials, commodities and energy sectors especially seem to have performed on this expectation. How realistic these expectations are - a few wise words from JP Morgan (via FTAlphaville)

The belief in certain quarters is that as long as the next government were to go all out at de-bottlenecking projects, sentiment would surge and this would spark an investment revival in the economy. However, this appears to be an overly-simplistic read on the situation for at least three reasons.
First, the vast majority of projects are currently stuck because of issues that are under the purview of state governments, over which the central government has little jurisdiction...

They also warn of the circular link between the bank bad loans and stalled infra projects. Do go read the full text. 

One thing is sure, we do have rallied a lot on expectation. Or rather hope. That is not saying we can't rally further. But given the uncertainties of election outcome, the tail risk of hung parliament results may not be a tail risk. That can rattled the market which seem to have priced in too many rosy assumptions