Nifty50 overvalued by 20%, expect correction in 6 months: Kotak Securities

Nifty index looks to be 20% overvalued as per our model after moving up more than 10 per cent in the last two months, it said

Brokerage Kotak Securities does not anticipate any large upside to the Nifty Index in 2024  and expects a time correction in the next six to nine months. 

As per its ‘Nifty fair value’ model, it believes the Nifty index is now close to 20 per cent overvalued. "Nifty index looks to be 20% overvalued as per our model after moving up more than 10 per cent in the last two months," said Anurag Singh of Kotak Securities.

In 2023, the domestic equity market experienced its most impressive performance since 2017, with the Nifty 50 and the Sensex rising by 20 per cent and 19 per cent respectively. Additionally, the midcap and smallcap indices were the star performers, with the BSE Midcap index soaring by 46 per cent and the Smallcap index surging by 48 per cent.

Kotak Securities estimates that Nifty will reach 21,834  by the end of the calendar year 2024, with the current Nifty standing at 21,418. The brokerage expects a period of consolidation in the Indian markets this year due to prevailing rich valuations

 

" The median pairwise correlations continue to be close to their long-term average. There was a slight uptick in index volatility in December. There were net upgrades to the EPS estimates in December, although the total number of estimate changes was low," it said in a note. 

The brokerage is wary of the absolute return potential of the market from the current levels. It has replaced ITC and Larsen & Toubro (L&T) with Britannia and PSU stock NTPC from its concentrated All-Season portfolio.

Its December 2023 concentrated All-Season portfolio comprises Nestle India, Britannia Industries, Tata Consultancy Services (TCS), Bajaj Auto  and NTPC.

The portfolio outperformed the Nifty index with annualised returns of 22.9 per cent versus 20.8% returns delivered by the latter. The December returns of its Concentrated All-Season portfolio were also higher at 10% versus 7.9% given by Nifty.

The broad All-Season portfolio, as of December 31, 2023

 The highest weight is carried by Nestle India, followed by Britannia.

Kotak's other portfolios that gave higher annualised returns than Nifty include Broad All Season (22.8%), Broad Fundamental (23.9%), Broad Low Volatility (21.1%), Broad Momentum (24.6%), Concentrated Sentiment (42.6%), Broad Sentiment (28.7%), Concentrated anti-factor (40%), Broad anti-factor (37.9%). 

Kotak Securities prefers mega-caps, noting their reasonable valuations and greater immunity in the event of any negative developments in the next few months. They believe the Indian stock market has three distinct markets within it, each with its dynamics and embedded expectations:

The mega-caps are in a bear market, with many large-cap stocks delivering modest positive or moderate negative returns in the past 2-3 years.

The large-cap and high-quality mid-caps are in a bull market, with the weak operating performance in the short term and likely deterioration in fundamentals in the medium term being largely ignored by the market.

 Several low-quality mid-caps and small-caps, in general, are in a bubble, with the market attaching unrealistic narratives to many stocks.

The brokerage believes large-cap stocks offer a better reward-risk balance due to more reasonable valuations compared to lofty valuations in most mid-and small-cap stocks.

What will result in a market correction?

Any market correction will be entirely based on a big change in the market’s expectations of potential returns. 

"We have no idea though as to what will change the market’s bullish return expectations, which have been reinforced by the stellar returns of the past three years for ‘new’ retail investors. We can point to a few fundamental factors, such as (1) earnings downgrades (although earnings misses are passe in the current state of irrational exuberance) and (2) higher-than-expected interest rates (unlikely). Increased focus on fundamentals versus flows may result in a correction, but we wonder why investors ask this question but stay invested," said the brokerage.


 Disclosure: Entities controlled by the Kotak family have a significant holding in Business Standard Pvt Ltd