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'The Nifty Index looks to be 20 per cent overvalued.'
Brokerage Kotak Securities believes the Nifty50 Index is overvalued by 20 per cent and expects a time correction in the next six to nine months.
"The Nifty Index looks to be 20 per cent overvalued as per our model after moving up more than 10 per cent in the last two months," said Anurag Singh of Kotak Securities.
In 2023, the domestic equity market experienced its most impressive performance since 2017, with the Nifty50 and the Sensex rising by 20 per cent and 19 per cent respectively.
The BSE Midcap Index soared 46 per cent and the smallcap index surged 48 per cent in the last one year.
Kotak Securities estimates that the Nifty will reach 21,834 by the end of the calendar year 2024, from the current levels of 21,633.
Going forward, the brokerage expects a period of consolidation in the Indian markets this year due to prevailing rich valuations.
'The median pairwise correlations continue to be close to their long-term average. There was a slight uptick in index volatility in December. There were net upgrades to the EPS estimates in December, although the total number of estimate changes was low,' it said in a note.
The brokerage is wary of the absolute return potential of the market from the current levels.
It has replaced ITC and Larsen & Toubro with Britannia and PSU stock NTPC from its concentrated All-Season portfolio.
Its December 2023, the Concentrated All-Season Portfolio comprises Nestle India, Britannia Industries, Tata Consultancy Services, Bajaj Auto, and NTPC.
The portfolio outperformed the Nifty Index with annualised returns of 22.9 per cent versus 20.8 per cent returns delivered by the latter.
The December returns of its Concentrated All-Season portfolio were also higher at 10 per cent versus 7.9 per cent given by Nifty.
The highest weight is carried by Nestle India, followed by Britannia.
Kotak's other portfolios that gave higher annualised returns than Nifty include Broad All Season (22.8 per cent), Broad Fundamental (23.9 per cent), Broad Low Volatility (21.1 per cent), Broad Momentum (24.6 per cent), Concentrated Sentiment (42.6 per cent), Broad Sentiment (28.7 per cent), Concentrated anti-factor (40 per cent), Broad anti-factor (37.9 per cent).
Kotak Securities prefers megacaps, noting their reasonable valuations and greater immunity in the event of any negative developments in the next few months.
They believe the Indian stock market has three distinct markets within it, each with its dynamics and embedded expectations:
The megacaps are in a bear market, with many large-cap stocks delivering modest positive or moderate negative returns in the past 2-3 years.
The largecap and high-quality midcaps are in a bull market, with weak operating performance in the short term and likely deterioration in fundamentals in the medium term being largely ignored by the market.
Several low-quality midcaps and smallcaps, in general, are in a bubble, with the market attaching unrealistic narratives to many stocks.
The brokerage believes largecap stocks offer a better reward-risk balance due to more reasonable valuations compared to lofty valuations in most mid and smallcap stocks.
What will result in the market correction?
Any market correction will be entirely based on a big change in the market's expectations of potential returns.
'We have no idea though as to what will change the market's bullish return expectations, which have been reinforced by the stellar returns of the past three years for 'new' retail investors,' the brokerage said.
'We can point to a few fundamental factors, such as earnings downgrades (although earnings misses are a passe in the current state of irrational exuberance) and higher-than-expected interest rates (unlikely).
'Increased focus on fundamentals versus flows may result in a correction,' it added. 'but we wonder why investors ask this question but stay invested.'
Feature Presentation: Aslam Hunani/Rediff.com
