Nifty Midcap Select: Are analyst projections an indication of an impending correction?

After a strong phase of outperformance , mid cap stocks are witnessing a a wave of profit booking move. Unlike the past few weeks, where a rotational profit booking was taking place, this time the correction is taking place across the board. Now how long it will continue will depend on how the SEBI advisory pans out and also how nifty moves. During this phase, analysts are bullish on select stocks from different sectors, some of which are either the leaders of their sector or part of the top three companies which are known to be well managed.

The Nifty IT index is probably the only sectoral index which has not formed a new high in recent weeks. The reason, it is one sector where analysts are least bullish in terms of expecting any upside over the next 12 months. However, the way stocks have moved in the last few days, it is clear that analysts were caught on the wrong foot. Stock Reports Plus, powered by Refinitiv, is a comprehensive research report that evaluates five key components of 4,000+ listed stocks - earnings, fundamentals, relative valuation, risk and price momentum to generate standardized scores.

While there are clear signs of large cap stocks making a comeback on the street, it is reflected both in movement of Nifty sensex. The problem is that as a word the “large cap” is so open ended and we keep seeing stocks moving in and out of that category which are the ones which one should focus on. If one looks at the last six months of the stock market moves, a new industrial house appears to be born and has caught the fancy of the street. Yes, we are talking about PSU as a set of companies. It is not owned by one individual but by the government of India so there is an element of the largest shareholder being one entity and that is why it may be called a new industrial house. Beside the ownership another common thread running in these companies is the impact of the clean up and restructuring of policy framework which has come in different sectors and in these companies in particular. So there is high probability and yes only high probability of these stocks doing relatively better in stormy conditions on the street.

Capital good companies had faced tough times for many years. Given the fact that hardly any capacity buildup was taking place in any industry, a number had to change their product portfolio and had to live with very low margins. But all the efforts have now started to show some results. Given the performance of the stock, a large majority of these stocks have hold recommendations from the analysts.

Last week two noticeable things happened in the market, first a sharp correction in mid-cap stocks and then on Friday sudden sharp recovery which was led by large cap stocks. To some it might appear what is noticeable in this ? This has happened many times in the last one year. The only difference is that it happened in the backdrop of the fact that even regulators are getting worried about what is happening to mid and small cap space and there has been an advisory. To the uninitiated, regulatory advisory tends to work in equity markets. This essentially means the probability of higher incremental flows to large cap stocks. Second, the kind of stocks which led the up move on Friday, it appears Nifty may do some catching up with mid and small cap indices in coming months. We take a look at stocks where even in large cap space, the broader financial matrix is better placed and sectors have one or the other tailwinds. This is not to say that if these stocks cannot see a correction, only higher probability of outperforming in strong correction. Yes, only higher probability.

Given the trend of short correction and sharp recovery which the market and especially Nifty has seen in the last few months, it appears that nothing can go wrong with the stock price. But there are enough examples from the recent past and also the long history of markets that most wrong investment decisions are made in these times. if one is thinking about increasing the exposure it would be better to stay with large caps. This is not to say that one would not be wrong in buying large caps but as they would be able to weather any storm which might emerge due to any reason, the damage would be controlled. Even in the large cap category stay with stocks, which dont find place in headlines very often but on many parameters are better than well known names and in fact their performance in the last one year is indicative that even the street is in mood to recognize them.

After a phase of relative under performance, will the year 2024 bring back the large cap into limelight. The valuation differential between, mid and large cap stocks has increased very sharply in the last one year, especially in the last nine months. Will the next few quarters see a mean reversion on this valuation gap as has happened in the past many times. Remember that the large size of the balance sheet has its own advantage, especially in time of correction, which one cannot rule out due to profit booking. ET screener powered by Refinitiv’s Stock Report Plus lists down quality stocks with high upside potential over the next 12 months, having an average recommendation rating of “buy” or strong buy . The screener applies different algorithms for all BSE and NSE stocks.

Unlike last quarter of 2023, when nifty and sensex used to witness correction and mid-cap index was able move higher. Since the start of 2024, the mid-cap index is also participating in the correction, clearly indicating that some profit booking is taking place in this segment of the market. Having said that, if one looks at the flow of money to the mutual funds, a good amount of it is still coming in funds which are focussed on mid or small cap. There is no way one can fight with liquidity, if it is going to mid caps and they are moving up irrespective of valuations or quality of stocks one cannot argue. But the only thing which as an investor one can do is to be careful when taking exposure to this segment of the market. Stay away from stocks where there is a narrative that this sector will do well because of ABCD reasons or the company will get such and such orders worth this much. There is enough evidence in history to show that more than anything else, checks and balances are most important at this point of time, while making investment decisions.