Smallcaps – should we buy now?

One thing certain in the market is cycles. Each asset class has its cycles. These cycles are driven by fundamentals, liquidity and various other factors. So be it Equity, Fixed Income, Rates each asset has its good and bad periods.

Similarly within Equities various sectors has its own cycles. There are phases when Autos outperform, some phases when Pharma outperforms while some periods when Banking stocks zoom. Also there are periods when smallcaps lag while some periods when smallcaps outperform.

The chart below shows how smallcaps have performed since 2004. The blue arrows show clear periods of bullish trends. 2004-2008, 2009-2011, and 2014-2017 have been outstanding periods to be invested in smallcaps in India.

The chart below shows the performance of Smallcaps and Nifty from Jan 2018 till date. Smallcaps are down 35% while Largecaps are up 10%.

See the chart from 2004 to 2007. Smallcaps were up 450% while Largecaps were up 200%

The message is clear. If we can get in somewhere near the beginning of an outperformance phase we can get huge alpha. So how do we identify the beginning of this phase? This is where Relative Strength charts help in point and figure.

The periods when we are above the triple moving average clearly show phases of outperformance of smallcaps vs largecaps.

Finally the  million dollar question – are we there yet? The chart shows we have moved above the averages. As long as we remain above all the averages and don’t give any sell below the averages it makes sense to have a huge weightage of smallcaps in our portfolio.

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