Market And Economy

Woolen Coats? Not In Summer!

DSP

May 14, 2025 4 mins

Summary

SMIDs are flying high but is that a sign to jump in or step back? A look at market cycles reveals a surprising pattern… and why large-caps might actually be the smarter bet right now.

Over the short term, stock markets tend to be unpredictable. But over a long enough period, they exhibit cyclical behaviour corresponding to what we call bull and bear markets.

And studying such cycles reveals insights that investors can base their moves on.

Let’s use such a cycle-oriented analysis to see which segment might be more promising right now: small- and mid-caps (SMIDs) or large-caps (LCs).

Consider the chart below that indicates the CAGR for small-, mid-, and large-caps between April 2003 and April 2025.

Source: Bloomberg, BSE, DSP. Data as of Apr 2025.

Notice that:

At the circled market peaks, the CAGR for SMIDs significantly exceeds the CAGR for LCs.
At the circled market bottoms, the CAGR for SMIDs is relatively close to the CAGR for LCs.

What this means is that in each upcycle, the SMID space exhibits stellar performance (typically due to an outsized contribution from smaller firms within that space).

This manifests itself as a significant outperformance of SMIDs over LCs in every upcycle.

However, during each downcycle, SMIDs lose almost all the alpha generated during the upcycle. This can be seen more clearly in the chart below.

Source: Bloomberg, BSE, DSP. Data as of Apr 2025.

Such behaviour is consistent with the higher volatility readings for SMIDs: greater price variation results in larger drawdowns and crashes during bear markets compared to the relatively shallower declines in large-caps.

So how can investors best capture the extra alpha offered by the SMID space?

Well, in general, investors are better off focusing on the margin of safety (i.e. the difference between a stock’s market price and its intrinsic value) rather than relying on recent outperformance.

The charts above make it clear that it makes a lot of sense to be aggressive with SMIDs when their alpha over large-caps has dipped significantly, because it bounces back over the next cycle.

Right now, however, SMIDs have a rather large alpha over large-caps. This means that currently, investors might be better served by sticking to large-caps. Just like you wouldn’t wear woolen coats in summer, it may not make sense to lean into SMIDs when they’ve already had a strong run.

For more actionable insights backed by data and analyses, we invite you to read the latest edition of Netra in its entirety.

Industry insights you wouldn't want to miss out on.

Disclaimer

This blog is for information purposes only. The recipient of this material should consult an investment /tax advisor before making an investment decision. In this material DSP Asset Managers Pvt. Ltd. (the AMC) has used information that is publicly available, including information developed in-house and is believed to be from reliable sources. The AMC nor any person connected does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Data provided is as of July 2024 (unless otherwise specified) and are subject to change without notice. Past performance may or may not be sustained in the future and should not be used as a basis for comparison with other investments. These figures pertain to performance of the index and do not in any manner indicate the returns/performance of this scheme. The statements contained herein may include statements of future expectations and other forward-looking statements that are based on prevailing market conditions / various other factors and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements.

All content on this blog is the intellectual property of DSPAMC. The User of this Site may download materials, data etc. displayed on the Site for non-commercial or personal use only. Usage of or reference to the content of this page requires proper credit and citation, including linking back to the original post. Unauthorized copying or reproducing content without attribution may result in legal action.. The User undertakes to comply and be bound by all applicable laws and statutory requirements in India.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.