In June we outlined a thesis for the Mid and Small-Cap segment of the market to begin outperforming in a meaningful way. In that post, we outlined a number of stocks we were buying to take advantage of that theme, but many are well on their way to their upside objectives already.
Today we want to follow up on that theme, show why it’s still intact, and outline stocks with an attractive reward/risk at current levels.
We’ve written extensively about what the Large-Cap/Small-Cap ratio means and how we interpret it. If you haven’t read them, I’d highly recommend checking them out before continuing with this post (June 9th post and June 19th post)
But, to sum it up the idea here is that Small-Cap outperformance is associated with a Bull Market in Indian Equities because it signifies risk appetite among market participants and a broad-based market rally that has sufficient participation from sectors/industry groups.
And so far we’ve been right, with the Nifty 50/Small-Cap 100 ratio falling about 10% since then…signaling Small-Cap outperformance. Our thesis remains intact as long as prices of this ratio are below 2.30, which they have been for the last two months.
Click on chart to enlarge view.
Here’s another perspective on that same chart, overlaying it with the Nifty 500. We believe the March low in the Nifty 500 and March high in the ratio were a major inflection point and continue to suggest we’re in a new bull market for stocks.
Now, let’s review the factors we used to identify long opportunities when this thesis began in June. Here’s an excerpt from that post:
“Our favorite way to identify stocks that foot this bill is by looking for trend reversals sparked by a failed breakdown and bullish momentum divergence. We’re constantly discussing setups like this, but the main characteristics we want to highlight are these.
- The stock reaches a long-term support level;
- Momentum is diverging positively; and
- A failed breakdown sparks the rally and allows us to define our risk. “
And here’s the setup in Bharat Electronics we shared then and how it’s fared since.
The stock has gained about 40% since this setup emerged, so today we’re going to look for stocks that are currently exhibiting similar conditions.
One of the new names on our list is Lakshmi Machine Works, which is breaking above 2,850 and confirming a failed breakdown and bullish momentum divergence. As long as prices are above 2,850, then these conditions remain intact and we can look for upside towards 5,400 over the coming months and quarters.
Other stocks like Emami Ltd. only have 2 of the 3 conditions present but are still worth a look on the long side since money continues to rotate into laggards. Our risk is so well-defined in these types of setups, we’re willing to overlook the lack of a momentum divergence and give them a shot.
The stock confirmed a failed breakdown below support at 255 but does not have momentum diverging positively. If prices are above that level, the bias is higher towards 460 over the coming months and quarters.
Any short-term weakness in either of these stocks should be viewed as a buying opportunity since they’ve successfully confirmed long-term bearish to bullish trend reversals. Given these are weekly charts, we’re less concerned about what they do tomorrow or this week and more with how they develop over the next few months and quarters.