Calibrate Hope

The argument about how smaller companies have a greater ability to run faster has been floating around for the past year. This argument is finding strong retail investor backing. Hope is driving retail investors to pour money into the mid-cap space. Past performance is seemingly the driver. If mid-cap earnings expanded the way they did over the years when large caps didn’t do much, then there must be serious merit in backing these companies when the economy recovers, right? Most investors found that argument flawless enough to blindly accept it. Questioning the argument was not an option given our anchorage to past performance of returns. This is where the problem began. The mid-cap space has been largely dominated by private investors and HNI’s during the lean market periods. They took all the good spots early. What retail investors have done in the past year is given the HNI’s and PE’s their celebration moment to open the bubble. As early converts to the mid-cap bandwagon saw results, others have been driving inflows into this space. The problem is there weren’t too many good ideas which had capital intake capacity. So, money chased a small basket of stocks. Valuations overshot and that is understandable. Investors are unwilling to take a pause and the MF industry is only too happy to gather money where investors want to give them. After all, gathering is the name of that game. The buyer beware principle is absent on the ground. The disappointing Q2 numbers of the mid-cap private banks have created a minor rattle to mid-cap funds. The markets are showing very low tolerance to under-performance or disappointment. This means that only good performance is priced in. Bad news from mid-caps is not priced in. If the economy takes longer to recover and grow, as clearly seems the case, we may see under-performing mid-caps getting punished. This will deliver a knock to NAV’s as the performing companies don’t enjoy much price headroom. On the other hand, a top-down recovery is definitely on cards and this should lead to a gradual recovery of large-caps. Investors seem to be getting themselves into a corner where they will be caught off-guard by the market’s swift correction. The window of time to create the right balance between large-caps and mid-caps is short and investors need to revisit their investments and swiftly re-balance.

“Earnings have a way of changing, and it’s far more fickle than assets. ” – Walter Schloss.

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