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Are Mid-caps Overvalued?

Equity markets began the week strongly but slowed down later in the week. Some positives emerged for the IT and banking stocks. The continuous rise has left the P/Es of mid-cap stocks rather high, and they could see a correction.

Most of the gains came in the early part of the week. The inflation rate crossed the 8 per cent mark but the markets did not seem too perturbed by it because it is expected to fall with any softening in crude prices. IT and bank stocks were in focus during the week – the former because of their constant effort at upgrading infrastructure, which is expected to add muscle power to their service offerings, and the latter because of a sensible move by RBI which will help them cut down on debt trading and thus lower treasury losses.

In the week's trading, the Nifty gained 1.56 per cent while the Sensex gained 1.98 per cent, primarily because of a strong showing by the large-caps on Monday. The broad markets too mirrored this trend with the S&P CNX 500 gaining 2.25 per cent and the CNX Mid Cap 200, reflecting the buoyancy surrounding mid-caps, moving up a whopping 4.28 per cent.

Among the various sectors, IT was in focus for most of the week. Satyam Computer was a major gainer after news that it had set up its largest global development centre in Melbourne, Australia. The positive sentiment triggered fresh buying in other large and mid-cap IT stocks. The BSE Healthcare gained 1.41 per cent during the week with pharma mid-caps gaining while the large caps remained flat. FMCG stocks continued to be depressed. And the BSE FMCG Index underperformed all other major indices gaining only 0.92 per cent this week.

The BSE PSU Index rose 1.75 per cent during the week. However, some of the gains registered earlier in the week were neutralised by a sharp, near 4 per cent rise in the prices of crude oil over the last two days. The BSE Bankex gained 2.63 per cent over the week, mainly on account of a strong showing on Friday, when the index gained almost 1.3 per cent after the RBI on Thursday announced that banks could now increase their Held-To-Maturity holdings above the current 25 per cent investment limit.

Volumes dipped on the bourses with the combined BSE and NSE average traded volume declining by 7.44 per cent. This is perhaps an indication of the cautiousness that is expected at high market levels. FIIs continued with their contrarian strategy, selling on Monday when the markets advanced and buying on days the markets declined. However, over the week, the FIIs increased their holdings on a net basis by Rs 147.9 crore. Mutual funds too increased their equity exposure in Indian markets by Rs 158.67 crore over the week.

One of the highlights of the equity story so far has been the rise and rise of mid-caps. However, investors are increasingly of the opinion that the rally has been far too broad-based for comfort and that there might well be some bubble mid-cap stocks. Hence, mid-caps could well see a correction in the coming few days.

The RBI's recent directive to allow banks to increase their HTM category investments should infuse a fresh spell of buying in banking stocks. The fortunes of petroleum stocks would vary with those of crude oil prices. The auto sector would take its cue from the interest rate scenario prevalent in the country. As an immediate rate hike can be ruled out, the auto sector's fundamentals should carry it forward. Be wary of the cement sector which has come under some pressure from stagnant demand in recent times. FMCG stocks too would probably lack direction in the short-term.

The markets could again come under a consolidation mode after this week's rise. But follow the mantra of "staying long with equities" and you would do well.