Stocks from the smallcap and public sector undertaking (PSU) space saw a sharp fall on Monday as investors continued to take money off the table, deeming recent gains as excessive.

The National Stock Exchange Nifty Midcap 100 and Smallcap 100 indices dropped 2.5 per cent and 4.01 per cent, respectively, with PSU stocks leading the decline.

Several PSU stocks declined by more than 5 per cent, resulting in a three-day market capitalisation erosion of state-owned enterprises nearing Rs 6.5 trillion.

In comparison, the S&P BSE Sensex fell 523 points, or 0.7 per cent, to close at 71,073. The Nifty ended the session at 21,616, a decline of 167 points, or 0.7 per cent.

Analysts said that a correction, especially in the broader markets and PSU stocks, was on the horizon as several stocks had surged solely on speculative buying, without much fundamental backing.

“A large part of this smallcap and midcap (SMID) rally (approximately two-thirds) was liquidity-driven (supported by strong domestic flows), whereas, for the Nifty, this was led by earnings delivery. As a result, valuations for SMIDs are now stretched, while, in comparison, Nifty continues to trade closer to its long-term average valuations. With heightened volatility in the first half of calendar year 2024, we continue to prefer largecaps over SMIDs,” said Arbind Maheshwari, head of India equities at BofA Securities.

Some market experts mentioned that smallcap and midcap and PSU sector stocks are losing support from high networth individuals and retail investors, who have been their key backers, due to elevated valuations.

In 2023, the Nifty CPSE Index rose by 73.7 per cent, while the Nifty Midcap 100 and Smallcap 100 rose by 46.6 per cent and 55.6 per cent, respectively.

On a year-to-date basis, the Nifty CPSE Index has gained 12.2 per cent, while the midcap and smallcap indices have risen by 3.2 per cent and 3.1 per cent, respectively.

“Quite a few retail investors entered the markets during the post-pandemic bull run, and they get nervous whenever institutional investors sell. The valuations are certainly not in favour of smaller investors, so while they may continue with systematic investment plans, they may exit some direct investments,” said U R Bhat, co-founder of Alphaniti Fintech.

Chokkalingam G, founder of Equinomics, said the earnings of many midcap and smallcap companies and PSUs do not justify the rise in their stock prices.

“Ultimately, unjustifiable valuations will push stock prices down because valuations may reach an elevated place, but the liquidity to sustain that valuation is not unlimited,” said Chokkalingam.

The correction in the PSU and midcap and smallcap segments will likely continue for a couple of weeks, as valuations haven’t moderated even after the recent fall.

The Nifty Midcap 100 is trading at a one-year forward price-to-earnings (P/E) of 27.8 against a five-year average of 23.3, and the Nifty Smallcap 100 is trading at a one-year forward P/E of 22 against a five-year average of 17.

The market breadth was weak, with 2,984 stocks declining gains and 1,004 stocks advancing.

ICICI Bank fell 1.5 per cent and was the biggest contributor to the Sensex decline, followed by HDFC Bank, which fell 0.9 per cent.

Last week, the Reserve Bank of India (RBI) kept rates unchanged for a sixth consecutive meeting, signalling that interest rates may not be lowered quickly.

Though keeping the rates unchanged was largely expected, the RBI’s decision to maintain the “withdrawal of accommodation” disappointed investors hoping the central bank would shift its stance to neutral and upset the bets with early cuts.

First Published: Feb 12 2024 | 8:19 PM IST

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