Valuation concerns return to Indian market, especially in Midcap stocks: Jefferies

The report pointed out that the recent market rally has pushed valuations to high levels, raising questions about sustainability and risks going forward.

Jefferies stated, "The rally in the market means valuations have become an issue again, particularly in the mid-cap space".The report highlighted that the benchmark Nifty Index is now trading at 22.2 times its 12-month forward earnings after rising 14.1 per cent from its recent low on April 7.

The midcap space has seen even sharper gains. The Nifty Mid-Cap 100 Index has surged by 23.7 per cent since April 7 and is now trading at a steep valuation of 27.1 times 12-month forward earnings.

Due to such high valuations, many corporates are once again placing equity in the market to take advantage of the bullish sentiment. The report added that the equity supply has increased sharply, with companies raising around USD 7.2 billion in May and USD 6 billion so far in June.

Jefferies noted that this wave of equity supply poses the main risk to the market. Before the market correction that began in late September last year, monthly equity supply was running at around USD 7 billion.

The report also highlighted a shift in market focus since the Union Budget announcement on February 1. There has been a noticeable rotation from investment-led themes to consumption-led themes.

This shift has been supported by a softer monetary policy environment, which has benefited consumer finance stocks. However, the report acknowledged that any upcoming investment cycle is likely to be slower and more prolonged, unlike the boom-bust cycle that occurred during FY03-FY17, which led to overcapacity, especially in the power sector.

The report outlined that while the Indian markets are enjoying a strong rally, especially in the midcap space, rising valuations and heavy equity supply could pose risks.