LINGERING CONCERNS

Despite the market rally, concerns about its sustainability and underlying fundamentals abound

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Mid-cap and small-cap stocks have witnessed a significant rally in recent months, outperforming the broader market. The BSE Sensex has risen by 13% in 2023, while mid-cap and small-cap indices have surged by 26% during the same period. This impressive performance has caught the attention of investors and analysts alike, but concerns have been raised about the rally’s sustainability and underlying fundamentals.

WHAT IS DRIVING THIS RALLY?

Following are some of the key theories for why mid-caps and small-caps have outperformed the broader indices after a long period of time:

Accommodative Monetary Policy: The Reserve Bank of India (RBI) has been maintaining a low-interest-rate environment to stimulate economic growth and counter the impact of the Covid-19 pandemic. This has resulted in ample liquidity in the system, which has flowed into riskier assets such as small-cap stocks.

When there is an abundance of liquidity, it tends to flow towards riskier assets, such as small-cap stocks. This is because small-caps are seen as offering the potential for higher returns.

Record Investment In SIPs: Apart from the increase in the number of new mutual fund folios, retail investors have poured in a lot of fresh money in small-cap and mid-cap funds. A record investment of ₹15,813 crore was made through systematic investment plans (SIPs) in India in August ’23. This shows that retail investors are increasingly investing in small-caps through SIPs.

Rising Number Of Demat Accounts: A record number of 3 million new demat accounts were opened in July ’23, indicating the growing retail participation in the stock market. This also shows that more and more investors are opening demat accounts to trade in small-caps.