Over the past year, we have witnessed a huge rally in the market, especially in mid-Cap and small-cap stocks. From 2020 Oct's low of 16000 Midcap nifty 100 has risen to an all-time high of 33,200. And a lot of individual stocks have seen more than 200% growth in one year, and a few even touching 400 to 600%. Same goes with small-cap stocks. Clearly, the mid-cap and small-cap have outperformed the benchmark NIFTY 50. Will this rally continue? Will mid-cap and small caps continue to outperform NIFTY 50 In general, small-cap and mid-cap stocks are more connected to the country's economic growth and they go hand in hand with the GDP growth. This is because usually, large caps derive their revenue from exports(TCS, Infosys, Reliance O2C biz, etc), but most of the small and mid-caps derive their revenue from local sales, and again the consumer base is the common man(the middle class) in India. If the economy is doing well, the average Indian would be earning well and would buy more products, and this is where small and mid-caps get their revenues from. So, in the next one year, if the economy does really great then the small and mid-caps are to benefit.
Coming to historic trends, the above graph plots the ratio between small or midcaps returns and the nifty returns. If the value is 20% that means the midcap or the smallcap has outperformed nifty 50 by 20%. It is clearly evident that after every outperformance in small and midcaps compared to nifty there is a relaxation or a cool off period, and a mean reversion can be seen in the following one to one and half years. The recent peak we saw in midcaps and small caps was in Oct of 2021, so according to historic trends, midcap and small caps are likely to show fewer returns and might underperform compared to 2021 returns for the next 12 to 18 months.