Midcap stocks have room to correct; buy the dips: Chris Wood

The sharp rally in the midcap stocks has made valuations expensive, and there is room for a correction, wrote Christopher Wood, global head of equity strategy at Jefferies in his latest note to investors, GREED & fear.

The midcap index, Wood said, now trades at 24.1x 12-month forward earnings compared with 18.7x for the Nifty. Rising crude oil prices, he believes, are another worry for India, which imports nearly 80 per cent of its annual crude oil requirement.

"In this respect, there is clearly room for a correction in the mid-cap area, most particularly as a continuing rise in the oil price has the potential to create some renewed inflationary noise in India, just as it does in the developed world. Still, by historical standards, valuations for the large-cap stocks are not particularly extended. Any pullback in the markets is a buying opportunity," he said.

Thus far in calendar year 2023 (CY23) the Nifty Midcap 100 index has surged 29 per cent, as compared to 11 per cent gain in the Nifty 50. This, Wood said, has largely been driven by a renewed pickup in domestic equity mutual funds’ flows, which hit Rs 29,000 crore in August, the highest level since March 2022.

Going with the flow

Meanwhile, foreign portfolio investors (FPI), too, have come back to Indian shores in CY23 and put in a net Rs 1.31 trillion in the Indian equity market (till September 8). In comparison, they had invested only Rs 59,539 crore in Indian equities during the same period in 2021, and withdrew around Rs 1.7 trillion between January – September 2022, data shows.

Domestic institutions, meanwhile, have kept the faith all this while, putting in Rs 28,313 crore between January – September 2021, Rs 1.62 trillion during the same period in 2022, and Rs 1.15 trillion in 2023 (till September 8), data suggests.

That said, the risks for the markets from a near-term perspective are mounting, analysts suggest. Even while remaining invested in this rally, investors, advises V K Vijayakumar, chief investment strategist at Geojit Financial Services, can consider some profit booking, particularly in the over-heated mid-and small-cap space.

"In the micro-cap segment, hope and momentum, not fundamentals are driving the rally. Even though the undercurrent of the market is bullish, the high valuations and risks like surging crude and rising dollar index can impact the market negatively. Brent crude at $94 is a major macro worry, which the market cannot ignore for long. The rising dollar index that has breached 105 and the attractive US bond yields (10-year at 4.28 per cent) will force the FIIs to sell aggressively soon," Vijayakumar said.

The rally in the Nifty 50 index from the 19,000 to the 20,000 mark has been quick – taking merely 52 trading days from July 2023 till September 2023, as compared to 18,000 to the 19,000 mark when the 50-share index took 425 trading sessions from October 2021 till June 2023.

The Nifty 50 now trades at a 12-month forward price-earnings (P/E) of 18.8x, a 7 per cent discount to its own long-period average (LPA), according to analysts at Motilal Oswal Financial Services (MOFSL).

"Although the Nifty-50 is at a new high and is creating a lot of buzz, on a two-year basis, it is up around 7 per cent from the October 2021 high. It also trades at a 12-month forward P/B of 3x, a 6 per cent premium to its LPA. The upside from here on will be a function of stability in global and local macros, and continued earnings delivery versus expectations," wrote Gautam Duggad, head of research for institutional equities at MOFSL in a recent note co-authored with Deven Mistry and Aanshul Agarawal.