Nifty drops 4% in less than 5 weeks despite attractive valuations in largecaps. What can reverse this trend?

The Indian stock market is extending sharp losses for the fifth consecutive week, with one of the most notable trends being weakness in the largecaps despite their attractive valuations. Analysts feel Dalal Street is moving closer towards a trend reversal, noting that the setup is ripe for largecap bulls to take charge.

Nifty 50, which comprises 50 largecap stocks, has lost 936 points (around 4%) since the downtrend began in the second week of August. Overall the index has fallen nearly 2% in September so far. In the meantime, the Nifty Midcap 100 index has fallen less than 1% while the Nifty Smallcap 100 index gained over 1.3% since the second week of August.

A major factor contributing to the weakness in largecaps despite their attractive valuations is that bulk of the steady monthly SIP inflows are going to the mid and smallcap segments despite their elevated valuations, said VK Vijayakumar, Chief Investment Strategist at Geojit Investments. He noted that a reversion to mean is overdue in the broader markets, and this can facilitate a rally in fundamentally sound largecaps.


Also read |Sensex drops 555 points, Nifty closes below 23,650 as market extends losses. How long will the downtrend continue?

Attractive valuations in largecaps

Nifty is trading close to its long-term average one-year-forward P/E of around 21x, while the Nifty Midcap 100 and Smallcap 100 carry premiums of 26-30% and nearly 50% over their own historical averages, Tanvi Kanchan, Associate Director at Anand Rathi Shares & Stock Brokers explained. She noted that part of the underperformance is flow-driven, with SIP money continuing to chase mid- and small-caps despite the stretched valuations, but part of it is also genuine earnings divergence, broader-market earnings have been growing faster than large-cap earnings this cycle.

Uttam Kumar Srimal, Deputy Head of Fundamental Research at Axis Direct, said that while a market shift toward largecap stocks is plausible over the near term, it remains a tactical rotation hypothesis rather than a guaranteed investment thesis. The primary drivers will be earnings performance, relative valuations, and liquidity flows rather than mega-IPOs alone.

Listing out key drivers that may support large-cap rotation, Srimal highlighted the valuation gap, month-end liquidity from IPOs, institutional flow preferences and mean reversion potential. Following a period of relative underperformance, largecaps present attractive entry valuations compared to the richer valuations in the mid and smallcap space, Srimal said, adding that anticipated mega IPOs such as those of Jio and NSE could draw significant institutional and HNI liquidity. Investors may rebalance into liquid large caps to fund or participate in these offerings, he added.

Further, both FIIs and domestic institutions favor large caps for ease of entry and exit, enabling swift portfolio realignments as risk sentiment shifts. After an extended lag, even marginal improvements in liquidity or earnings expectations can trigger a catch-up rally across the large-cap segment, Srimal noted.

Also read | Nifty slips below critical support level of 23,600 as market reacts to global economic uncertainties

What should investors do?

The Axis Direct analyst advised investors to view this movement as a short-to-medium-term tactical catch-up, highly dependent on underlying earnings breadth and market liquidity. He said investors should focus selectively on largecap equities offering strong earnings visibility coupled with reasonable valuations, rather than taking passive, indiscriminate exposure to the broader Nifty index.

“The sharp outperformance of mid and smallcap stocks over the past five to six months may be difficult to maintain going forward. From a strategic perspective, a greater focus on largecap stocks and non-equity ETFs appears safer. Sector-wise, defensive and deep-value areas such as healthcare, telecom, FMCG, diversified businesses, and IT can continue to provide an edge to the portfolio,” said Vinod Nair, Head of Research at Geojit Investments.

How can NSE, Jio IPOs reverse largecap underperformance?

While the timing of the transition of investor interest from broader markets to the largecaps is hard to predict, Vijayakumar from Geojit Investments feels this is likely by September-end when the mega IPOs of NSE and Jio are completed and refunds from the IPOs come back to investors. “Instead of trying to time the market, investors can think about changing the weightage of portfolios towards largecaps where the risk-reward is favourable,” according to Vijayakumar.

Market regulator Sebi approved NSE’s draft IPO papers on Friday. The stock exchange’s much-awaited IPO, expected to raise around Rs 30,000 crore, will comprise an offer-for-sale (OFS) of up to 14.89 crore equity shares.

Jio Platforms could be even larger. The telecom, digital and technology arm of Reliance Industries is estimated to be targeting an IPO of around $4 billion, or roughly Rs 37,800 crore, potentially making it the largest IPO in India. The company plans to formally kick off investor outreach for its IPO as early as next week, Bloomberg reported.

Also read |IPO pile-up swells to Rs 4.67 lakh crore: Will money move from Sensex, Nifty to primary markets?

Disclosure: "This article has been written by Debaroti Adhikary, who is not a SEBI-registered Research Analyst or an Investment Adviser. Debaroti Adhikary and her ‘relative(s)’ (as defined under Section 2(77) of the Companies Act, 2013) do not hold any financial interest in the companies mentioned in this article as of the date of publication. The views/recommendations mentioned in this article, wherever applicable, are those of the respective SEBI-registered Research Analyst/brokerage and have been reproduced/reported with due attribution. They should not be construed as the views or recommendations of The EconomicTimes Digital or the journalist. Readers are advised to consider the original research report and make their investment decisions based on their own assessment."