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 Bulls are still having the upper hand even as the pullback in the Sensex and the Nifty indicates otherwise. On the BSE, 2,126 stocks have advanced and 1,955 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 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 doing well over a year or so. Now, the mid and small-cap stocks would probably do well. Small investors, when they come to markets, fancy the small and midcap stocks,” said UR Bhat, founder of Alphaniti Fintech.
“The bull run comes to small caps after a rally in the overall market. And once the overall market rallies, it gives confidence to new and not-so-active investors, and there is a rush to the market. And these new and inactive investors start chasing small and mid-cap stocks. And then it fizzles out because of stretched valuation and lack of liquidity. Now is the right time to cut down exposure to small and mid-cap based on valuation and exit the wrong stocks one might have bought,” said G Chokkalingam, founder of Equinomics.
Following the sharp up-move, the earnings yield spread of mid-caps, small-caps, and micro-caps to large-caps has turned unattractive, which will likely result in muted returns going ahead, cautioned a note by ICICI Securities earlier this month.
“The Nifty 50 index is consolidating just below the 20,000-mark after rallying 14 per cent from March lows while robust earnings expansion catches up, thereby indicating rational behaviour. However, bull market frenzy is visible in the mid, small and micro-cap indices. Technically, a more than 20 per cent upside indicates a bull market. Earnings yield spread of mid- and small-caps over large-caps evaporates to zero while it contracts significantly for micro-caps to about 70 basis points, indicating extremely low risk aversion,” said the note.
The earnings yield for small-caps currently is about 4 per cent compared to its 10-year average of 6 per cent. Similarly, earnings yield for mid-caps is 4.8 per cent vis-à-vis a 10-year average of 5.6 per cent.
Experts caution the sustained up-move in the market this year could be a trap for retail investors.