Mid-caps, small-caps soar despite no material change in fundamentals; irrational exuberance could be at play, says Kotak

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Kotak Institutional Equities in a report on September 11. Mid and smallcap indices have been on a record-setting spree for the last several sessions. The BSE Midcap index has jumped nearly 31 per cent this year so far while the BSE Smallcap index has jumped 33 per cent this year.

Benchmark Sensex has jumped 10 per cent this year so far. "We see a limited point in trying to find fundamental reasons behind the steep increase in stock prices of several mid-cap and small-cap stocks. There is no meaningful change in the fundamentals of most companies; in fact, they have worsened in many cases.

The primary driver of the rally appears to be irrational exuberance among investors, with high return expectations (and purchase decisions) being driven by the high returns of the past few months," said Kotak Institutional Equities. Some of the mid-cap stocks, such as IRFC and REC have surged 175 per cent and 117 per cent, respectively, in the last six months. While in the small-cap space, shares of Mazagon Dock (up 198 per cent), BSE (up 184 per cent), Suzlon Energy (up 180 per cent), Rail Vikas (up 154 per cent), Cochin Shipyard (up 151 per cent) and Kalyan Jewellers (up 110) have surged over 100 per cent in the last six months, Kotak pointed out.

Kotak underscored that the fundamentals of most sectors have not changed much. However, market sentiment is quite exuberant, based on (1) a steep increase in the prices of many mid-cap and small-cap stocks, (2) large inflows into mid-cap and small-cap mutual funds, and (3) a huge number of new retail participants in the mid-cap and small-cap funds. "The strong performance of the mid-cap and small-cap indices has possibly pushed up return expectations among retail investors," Kotak said.