The benchmark indices are set to end their five-month gaining streak, but the market breadth continues to hold strong
So far this month, stocks gaining have outnumbered those declining, a sign that the bulls still have the upper hand, even as the pullback in the S&P BSE Sensex and the National Stock Exchange Nifty indicates otherwise.
On the BSE, 2,126 stocks have advanced and 1,955 have declined in August, translating into an advance/decline ratio (ADR) of 1.1.
The ADR for the domestic market has remained above 1 since April amid outperformance in the broader market.
An ADR of less than 1 — as seen during the initial three months of calendar year 2023 — indicates negative market breadth.
“The breadth of the market has improved. Investors think that top stocks have done their bit, as they have been performing well for over a year or so.
"Now, the small- and mid-cap stocks will likely perform well.
"Small investors, when they enter the markets, favour the small- and mid-cap stocks,” says U R Bhat, founder, Alphaniti Fintech.
The Sensex and the Nifty reached their 2023 lows in March at 65,087 and 16,828, respectively, and have since rebounded by close to 15 per cent from those levels.
The Nifty Smallcap 100 and the Nifty Midcap 100 have surged by 40 per cent and 34 per cent from their lows in March.
“The bull run extends to small-caps after a rally in the overall market.
"Once the overall market rallies, it instils confidence in new and less active investors, resulting in a rush to the market.
"These new and inactive investors start pursuing small- and mid-cap stocks.
"However, this momentum fizzles out due to stretched valuations and a lack of liquidity.
"Now is the right time to reduce exposure to small- and mid-caps based on valuation and exit any incorrect stock purchases,” says Chokkalingam G, founder, Equinomics Research & Advisory.
Following the sharp upmove, the earnings yield spread of micro-caps, small-caps, and mid-caps to large-caps has turned unattractive, likely resulting in muted returns, as cautioned in a note by ICICI Securities earlier this month.
“The Nifty50 is consolidating just below the 20,000-mark after rallying 14 per cent from March lows, while robust earnings expansion catches, thereby indicating rational behaviour.
"However, a bull-market frenzy is visible in the micro-, small-, and mid-cap indices.
"Technically, a more than 20 per cent upside indicates a bull market.
"The earnings yield spread of small- and mid-caps over large-caps evaporates to zero, while it contracts significantly for micro-caps to about 70 basis points, indicating extremely low-risk aversion,” stated the note.
The earnings yield for small-caps is currently about 4 per cent, compared to its 10-year average of 6 per cent.
Similarly, the earnings yield for mid-caps is 4.8 per cent, vis-à-vis the 10-year average of 5.6 per cent.
Experts caution that the sustained upmove in the market this year could be a trap for retail investors.
“When the action shifts to small- and mid-cap stocks, more and more investors enter the market.
"As more investors participate, these stocks start performing well.
"It’s a virtuous circle as long as it remains unbroken.
"However, when a correction occurs, it will likely be steep. A correction is inevitable. The question is when.
"There aren’t many positive triggers left for the market, as everything has already transpired,” says Ambareesh Baliga, an independent equity analyst.
