Only 10% of Nifty 500 stocks trading above 200-DMA; VIX indicates market not yet bottomed out, says report

The report notes that excluding the banking and financial services sector (BFSI), small and midcap earnings have contracted year-over-year, marking a significant reversal from previous years.

The Indian equity markets are witnessing a broad-based decline in valuations as stocks adjust to a slowdown in earnings growth, according to the latest DSP Netra report.

The report highlights the fact that currently only 10 percent of Nifty 500 stocks are trading above their 200-day moving average. This could signal broad market weakness, as per the report. The report further states that 155 stocks have hit new 52-week lows.

Historically, markets have seen that stability emerges when more than 200 stocks reach this level. “But despite a 16 percent Nifty drop, the Volatility Index (VIX) remains low, suggesting investor fear hasn’t peaked,” it states. The report also suggests that the current subdued levels of the VIX may indicate the market may not have bottomed yet and hence there could be further corrections before recovery takes place.

According to the report, the proportion of stocks trading below 3x price-to-book (P/B) ratio has risen to 33 percent (or 1 in 3 stocks) in the Nifty MidSmall 400 Index. This is an increase from 25 percent in September 2024.

The report explains that a healthy market sees at least half of all stocks trading below a 3x P/B ratio when return on equity (ROE) levels hover around 15%. While the market is not yet at that point, further adjustments may bring valuations closer to long-term averages, it says.

Currently, as per the report, valuations of large cap stocks are near historical averages with the Nifty 50 price-to-earnings (P/E) ratio falling below 20x and the price-to-book (P/B) ratio for Nifty 50 reaching close to its long-period average of 3.3x.

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While the report notes that corrections have improved valuations for large cap stocks, more corrections may be needed to make the investing opportunity more attractive. Currently, market capitalization-to-GDP ratio remains slightly above its historical trend, it states.

Experts suggest that another 8-10 percent price correction or continued earnings growth will provide stronger investment opportunities.

On the other hand, small & mid-cap stocks may still be overvalued, as per the report. The median trailing twelve-month (TTM) P/E ratio for SMIDs currently stands at 33x, down from 46x at the 2024 peak but still above the long-term average of 20x. Profits in SMIDs have also underperformed large caps for two consecutive quarters due to a domestic economic slowdown, as per the report.

The report notes that excluding the banking and financial services sector (BFSI), small and midcap earnings have contracted year-over-year, marking a significant reversal from previous years.

Going ahead, the pace of flow in small and midcaps could slow down, leading to softening of valuations, according to the report. It explains that the pace has been exceptional and was fuelled by “strong performance” with MF flows into the universe reaching 8.2 percent of its free float over the last 12 months.

Additionally, the report notes that small cap assets held by active equity funds rose 10x since March 2020 against a 4x growth in the large cap space. “As returns soften, incremental flows to Small caps are likely to decline, reducing excess valuation froth,” added the DSP report.

What next for investors?

The report notes that a combination of softer stock prices and improving earnings growth will help restore valuations to long-term sustainable levels. However, it cautions that small and midcap stocks may still have further downside risk before reaching a stable investment zone.

For investors, the report suggests a shift from a conservative to a moderate stance adding that currently it is not the right time for aggression. It also advises investors to raise equity exposure through fresh deployment by way of hybrid funds such as Dynamic Asset allocations or Multi Asset Allocation strategies.

It also suggests investors to top up their SIPs and focus on large caps for staggered purchases and equity allocations. The report also notes that currently it is not the right time to become aggressive in allocating to small and mid- caps yet.