70% of Mid- and Small-Cap Stocks Overvalued; Prashant Jain Warns of Underperformance

Overvaluation Remains a Concern for Small- and Mid-Cap Stocks

Prashant Jain, a veteran investor with decades of experience, has raised concerns over the continued overvaluation of small- and mid-cap stocks, commonly referred to as Smids. In a recent interview, Jain highlighted that approximately seven out of ten of these stocks are still overvalued, despite the recent selloff that has led to sharp declines in their prices. While the pace of the decline may have slowed, Jain foresees an extended period of underperformance for these stocks, as many of them are yet to return to fair value.

• Seven out of ten small- and mid-cap stocks remain overvalued, according to Prashant Jain.

• Despite recent declines, extended underperformance is expected in the Smid-cap sector.

• Valuation concerns persist, even with the recent correction in the market.

Market Correction: From Rapid Decline to Slow Stabilization

Jain noted that the sharp declines in small- and mid-cap stocks, which saw drops of 30-50% in recent months, may have temporarily cooled the market. However, he emphasized that valuations are still stretched and likely to remain so. Jain expects the next phase of correction to be much slower but prolonged. He stated that the rapid pace of decline has likely eased, but the market correction is far from over, and stocks may continue to experience gradual downward pressure.

• The market correction in small- and mid-cap stocks may now take the form of a slower, more prolonged decline.

• Recent declines may have temporarily stabilized, but overvaluation concerns remain.

• Expect a slower pace of correction moving forward.

Reversal in Momentum: The End of the Narrative-Driven Phase

Jain attributed much of the rally in small- and mid-cap stocks to narrative-driven themes, including Make in India, China Plus One, renewables, electric vehicles (EVs), and sectors like defense and railways. These themes attracted investor enthusiasm and led to significant growth in many stocks. However, Jain believes that this phase is now coming to an end, and the market is shifting towards a phase where stock selection will play a more critical role. He warned that the broad-based optimism around certain sectors would give way to wider dispersion in stock price movements, even within the same sector.

• Narrative-driven investing has been a major factor in the rally of small- and mid-cap stocks.

• Themes like Make in India, EVs, and renewables were significant growth drivers.

• Stock selection will become critical, with wider dispersion expected in future stock price movements.

Large Caps to Remain Range-Bound, Says Jain

When it comes to large-cap stocks, Jain expects them to remain range-bound for the near future. While he acknowledged that it is challenging to predict market movements in the short term, he indicated that the Nifty index will likely move within a defined range. Jain’s outlook for large caps is less bearish than for small- and mid-cap stocks, as large-cap stocks tend to have more stable growth driven by overall economic and corporate earnings growth. He believes that over time, equities, in general, should trend upward, aligning with long-term economic growth.

• Large-cap stocks are expected to remain range-bound for the time being.

• The Nifty index is likely to show limited movement in the short term.

• Over time, equities should grow in line with economic and earnings growth.

Valuation Expansion in Sectors: A Risk of Reversal

A significant portion of the rally in small- and mid-cap stocks in recent years can be attributed to the valuation expansion of sectors that saw high levels of investor interest. However, Jain cautioned that once a sector experiences significant valuation expansion, the reversal in momentum is unlikely to occur quickly. He pointed out that the momentum reversal could lead to further downward pressure on stock prices, particularly in sectors that have been driven by speculative investment rather than fundamental growth.

• Valuation expansion in sectors could lead to significant corrections.

• Momentum reversal is expected to be slow, leading to further downward pressure on stock prices.

• Investors must focus on fundamentals rather than speculative trends.

Looking Ahead: Slow Recovery Expected for Smid-Cap Stocks

Jain’s outlook for small- and mid-cap stocks remains cautious, despite the steep declines in recent months. He believes that while the rapid pace of decline has slowed, it is still too early to expect a full recovery. The stocks in this category will likely continue to underperform in the near term as investors reassess the valuation levels and fundamentals of these companies. Furthermore, the shift away from narrative-driven investments means that only companies with strong fundamentals and growth potential will stand out in the future.

• A slow recovery is expected for small- and mid-cap stocks.

• Investors must reassess the valuation levels and fundamentals of companies.

• A shift away from narrative-driven investing will lead to more discretionary stock selection.

Emphasis on Stock Selection and Fundamental Analysis

Prashant Jain’s commentary underscores the importance of stock selection in the current market environment. While market trends and sectoral themes drove much of the investment in small- and mid-cap stocks, the coming months will require investors to focus more on fundamentals. Jain cautioned that the days of easy gains driven by speculative investments and thematic narratives are behind, and moving forward, investors will need to carefully assess earnings growth, valuation metrics, and long-term sustainability.

• Stock selection will become more critical than ever in the current market environment.

• The market shift requires a focus on fundamentals, not speculative narratives.

• Earnings growth and valuation metrics will be key indicators for investors.