NSE midcap at new peak, leaves investors wary

The benchmark CNX Midcap 200 index continued to seek new highs Wednesday, fuelled by sustained domestic buying.

However, the valuation gap between top-tier and mid-cap shares has widened significantly and investors may have second thoughts about buying mid-caps at these levels, market players said.

On Wednesday, the NSE Midcap 200 index ended at 1928.10 points, an all-time closing high, after having touched a new 52-week and lifetime high of 1937 earlier in the session.

Since the start of July, the mid-cap index has risen by roughly 26 per cent, compared with a 10 per cent rise in the Sensex and the Nifty.

Stocks such as Nav Bharat Ferro Alloys and Hindustan Oil Exploration have risen around 120 per cent, while others like South East Asia Marine Engineering, Gujarat Alkalies, Aban Lloyd Chiles, Motherson Sumi, Sintex Industries and Essar Steel have risen between 70-90 per cent.

According to market watchers, the frenzied buying in mid-caps was triggered by the proposed changes in the capital gains structure and the new securities transaction tax.

But the party may now be nearing an end. In a note to clients Monday, investment bank CLSA Asia Pacific sounded a cautious note on the performance of mid- and small-cap stocks following the recent run-up in stock prices.

According to CLSA, the CNX Midcap 200 is quoting a price earnings ratio of 14.4 times estimated 2004-05 earnings, a 13 per cent premium to the Sensex forward PE of 12.5.

"The additional risks associated with small- and mid-caps do not justify a premium to the large caps," CLSA said.

The lack of institutional interest overall is borne out by the fact that the net foreign fund inflows of $260.6 million were the second lowest during this calendar. A significant chunk of the $612.5-million inflow in August came via the Tata Consultancy Services initial public offer.

Domestic mutual funds sold close to 6 billion rupees worth of stock in July and August combined.

"I don't think the rally in mid-caps will last much longer, as many stocks have risen around 30-40 per cent over the last few weeks," said Ambareesh Baliga, vice president, equities, Karvy Stock Broking, adding that market operators have already begun unloading shares over the last few sessions.

"There has to be a decent correction before one can re-invest in mid-caps. We are advising booking profits at these levels," he said.

Frontline shares have been struggling for direction over the last one month, weighed down by volatility in global crude oil prices, climbing inflation and earnings growth worries.

According to Vinay Motwani, vice-president, Prime Broking, a sharp movement either way is unlikely unless there are some strong earnings surprises next month, or global crude oil prices start rising again.

While mid-caps shares can outperform frontliners purely on liquidity support in the short run, it is difficult to sustain the trend over a longer period.

"It is difficult to say how long this rally (in mid-caps) will last, especially because the broad indices are near important resistance levels," said Jamshed Desai, head of research, IL&FS Investsmart India Ltd., adding that the upswing has been so far driven mainly by domestic buying.

This view is shared by Baliga. "The Sensex is likely to find it difficult to go much beyond 5300 near-term, which indicates that the current rise in mid-caps may also be difficult to sustain," he said.

While the initial buying in mid-cap shares was sparked by attractive valuations, it is market operators who are now calling the shots in most stocks, dealers said.

Few players are willing to bet on how sharp the correction is going to be or how long it would last.

Usually, mid-caps rise at a scorching pace, but also hurtle downward at an equally rapid pace. After touching a record high of 1895.40 in January this year, the CNX Midcap 200 shed close to 23 per cent over the next two months, as profit sales set in.

After recovering to 1828 by the last week of April, the index again shed 23 per cent over the next two months on concerns over the pace of economic reforms following the change of guard at the Centre.