Why Monday mayhem was not surprising

Steep valuation might have led to profit-booking, thus exacerbating the selling

It was bloodbath on D-Street on Monday, as sheer panic gripped investors making them bolt for the exit. Smaller stocks bore the brunt of the selling. While the Nifty closed 1.58 per cent lower, the Nifty Midcap 100 index lost 2.72 per cent and the Nifty Smallcap 100 closed 2.6 per cent lower.

This fall is, however, not surprising given the runaway rally in the India market over the last two years. With domestic liquidity swamping mutual funds, they have been zeroing-in on select stocks and sectors with better promise, thus making them pricey. While the trigger for the recent fall was the concern about the health of NBFCs, it could also be due to profit-booking given the pricey valuation of Indian stocks.

The panic in housing finance stocks caused by news of DSP Mutual Fund selling commercial papers of DHFL at a higher yield in the secondary market — continued to cast a cloud over HFCs, NBFCs and the realty sector on Monday as well. Nifty financial services index lost 3.4 per cent for the day, while the Nifty Realty index was the worst hit, down 5.3 per cent.

Global headwinds in the form of a fresh phase of trade war erupting between the US and China, Brent crude hitting $80 and a broad based sell-off in emerging market currencies, making rupee slip further, added to the pressure on indices.

 

Valuation worries

While there are sufficient reasons for the near-term decline, the bigger concern is the incessant rally in Indian stock market since February 2016 which has made Indian stocks, the priciest ones globally. The Nifty 50 index had gained 72 per cent from the February 2016 low to the recent high. The corrections over the last two years have been quite shallow, barely exceeding 10 per cent. The rally in Nifty Midcap 100 and Nifty Smallcap Index has been sharper at 90 and 125 per cent, respectively.

If we consider the movement of the global benchmarks since the beginning of 2018, the Sensex and the Nifty are up 6.6 and 4.1 per cent, respectively. Many of the other global benchmarks have reported losses in this period due to the trade war tension and a galloping crude oil price.

The price earning multiple at which the Nifty Midcap 100 index is currently trading is at a steep 35 times, according to Bloomberg. The Nifty Smallcap trades at 233.9 times, possibly due to poor financial performance of the index constituents. The small-cap segment faces the highest risk as poor liquidity results in taking prices steeply higher, once institutions begin buying them. Similarly, price decline is also sharper in this segment.

A bottom-up approach

It’s clear that classic defensive sectors such as IT, FMCG and pharma seem to have fared much better compared to others. But it is best to be stock specific if you want to start preparing your shopping list. With stocks across market capitalisation getting the stick, it would be better to buy blue-chips at attractive valuations now, rather than go for riskier smaller businesses.

Also, with the trade war set to go on for some more time and the rupee continuing to look vulnerable, you might be able to get stocks at better prices a little later. So, best to stagger your buys.

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