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Valuation worries loom over smallcap stocks

By Puneet Wadhwa & Rex Cano
February 21, 2024 13:05 IST
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It has mostly been a one-way street for smallcap stocks that have taken it on their chin thus far in February.


Illustration: Uttam Ghosh/

The Nifty Smallcap 250 index has shed 3.2 per cent in the current month as compared to the 1.8 per cent decline in the Nifty Midcap 100 and the 0.5 per cent drop in the Nifty 50 index, data showed.

Technically, the index has slipped below its 20-day moving average (DMA) placed at 14,800 levels on Monday, and is currently testing the 50-DMA, and is placed at 14,278 levels.

It slipped below the 50-DMA in November 2023, too, before posting a recovery.


In January 2024, the Nifty Smallcap 250 index slipped below the 20-DMA but bounced back around 9 per cent thereafter.

So, is there a scope for a bounce back in the smallcap stocks in the current fall, or are we in for a prolonged downtrend?

From a short to medium-term perspective, analysts expect the ongoing correction to continue, as a number of these stocks saw a sharp rally in the last few months.

That said, they do not rule out short intermittent bouncebacks.

In the calendar year 2023 (CY23), for instance, the Nifty Smallcap 250 index surged 48.1 per cent as compared to a 43.7 per cent rise in the Nifty Midcap 150 index and a 20 per cent gain in the Nifty50 index.

Several stocks in the broader markets, according to V K Vijayakumar, chief investment strategist, Geojit Financial Services, were driven by speculative buying without consideration for fundamentals.

These stocks, he said, are correcting now.

This trend is likely to continue since many such stocks are excessively valued.

The explosive growth in the number of demat accounts and the newbies chasing mid and small-caps influenced by recency bias have contributed to this froth in the broader market.

A correction in this segment is inevitable and desirable, which will give opportunities to buy fairly valued stocks in this segment like public sector banks,  Vijayakumar said.

The only solace for investors in this space for now is the fact that the Nifty Smallcap 250 index is still trading above its 200-day moving average (DMA) placed at 12,066 levels.

For long-term investors, the simple 200-DMA provides a broad outlook of the longer-term trend.

Stocks and indices trading above this key 200-DMA level exhibit strength and are likely to rally, while those trading below this level are viewed as bearish, with the stock/index expected to see a selloff.

At the current levels, 193 stocks that comprise the Nifty Smallcap 250 index are trading above their respective 200-DMA levels, while 56 stocks are trading below this, according to data.

Ajit Mishra, senior vice-president for technical research at Religare Broking suggests that though the smallcap index can attempt to recover losses, traders should use a rise to exit the stocks.

This type of fall has happened in the past as well and the index had recovered lost ground. The same can play out this time as well.

That said, the RSI reading on the weekly chart of 75-80 indicates that the index is in an overbought zone and there can be selling pressure at higher levels.

A recovery in the index should be used to cut positions until the index trades above 16,200 levels decisively.

We are still in a  sell on a rise  market, Mishra cautioned.

G Chokkalingam, head of research at Equinomics Research, believes the valuation of small and midcap (SMC) segments is elevated and needs a significant correction from the current levels.

The risk to the SMC segment is steadily growing in the short-term due to rich valuations and possible liquidity shortage for this segment.

As a broad investment strategy, we recommend allocating 5 per cent to 10 per cent to cash and gold ETFs respectively, and 50 per cent to largecaps, he added.

Disclaimer: This article is meant for information purposes only. This article and information do not constitute a distribution, an endorsement, an investment advice, an offer to buy or sell or the solicitation of an offer to buy or sell any securities/schemes or any other financial products/investment products mentioned in this article to influence the opinion or behaviour of the investors/recipients.

Any use of the information/any investment and investment related decisions of the investors/recipients are at their sole discretion and risk. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Opinions expressed herein are subject to change without notice.

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Puneet Wadhwa & Rex Cano
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