Nifty’s Overvaluation Suggests Impending Market Correction:
The frontline indices of the stock market appear to be on the cusp of a significant correction, projected to be in the range of 5 to 10 percent. In contrast, small-cap and mid-cap stocks are anticipated to endure even more severe drawdowns, reflecting a broader fear of market overvaluation. Emkay Global, a prominent domestic brokerage, has taken a distinctly cautious approach under these conditions, marking the initiation of a “key avoids” list that highlights specific stocks and sectors deemed too risky at current valuation levels.
This cautious stance is rooted in the observation that the valuations associated with the Nifty index have reached stretched levels, particularly in light of the market already pricing in a positive budget outcome. With the absence of any favorable triggers to support further price increases, Emkay suggests that a sell-off is inevitable in the near term. Moreover, they emphasize that the upcoming earnings season for the first quarter of fiscal year 2025 (Q1FY25) is expected to be lackluster. When coupled with projections that interest rate cuts may not materialize until the latter part of calendar year 2024 (end-CY24), this scenario is likely to exacerbate existing bearish sentiments among investors.
In examining the current market landscape, it becomes evident that many frontline stocks are experiencing frothy valuations. The Nifty index is currently trading approximately 10 percent above its five-year historical mean, reflecting a price-to-earnings ratio (PER) of 21.4 times the one-year forward earnings. On a broader scale, the valuations for the NSE Midcap 150 index stand at an eye-watering multiple of 42 times trailing earnings, while the NSE Smallcap 250 index is valued at 31 times trailing earnings. These figures represent substantial premiums—52.5 percent and 35.5 percent, respectively—over their corresponding five-year averages.
Emkay Global articulates that, even when considering the robust growth outlook that some sectors may promise, such elevated valuations are likely to result in diminished returns over the near term. They caution that an imminent market correction is not only plausible but may be necessary to realign price levels with more sustainable valuation metrics. The brokerage further posits that only significant upgrades in forward earnings estimates could provide the necessary support for maintaining these high multiples. However, they express skepticism about the likelihood of such upgrades occurring in the next one to two quarters, reinforcing their cautious outlook on the market’s trajectory going forward.
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