Market correction: Decoding the fall and where to invest now

Markets have been giving investors the chills in recent months, with the Nifty losing 15 per cent since it peaked on October 18 last year. A dissection of the top 500 stocks by market capitalisation shows the rout is deeper across the broader markets. But the silver lining is that valuations are correcting and sector rotation is in place, presenting some pockets of opportunities for long-term investors. Here are takeaways from the fall, what could lie ahead and ways to play the market correction. Note that the analysis is based on data as of June 17. Though the market has pulled back a bit from those levels, the underlying trend does not change. Wherever index fall is are mentioned, June 24 (latest) numbers are considered.

All fall down

So far, the Nifty 500 is almost in sync with the Nifty, losing 15 per cent from the October market peak. However, a dissection of the index constituents show deep cuts, with 21 stocks nose-diving over 50 per cent, and over 150 stocks losing 30-50 per cent. In all, 83 per cent of the Nifty 500 basket has corrected. In fact, nine stocks have wiped off the entire gains made from the March 2020 lows — prominent among them being Whirlpool, HDFC AMC and Mahanagar Gas.

As can be expected during any downturn, small-caps are the most impacted, with the Nifty Smallcap 250 index falling by a higher 19.7 per cent. Average returns of the 203 small-cap stocks, which are part of the Nifty 500, stand at about minus 30 per cent. While the Nifty Midcap 150 indices have fared worse than the bellwether or the broader market index, mid-cap stocks that are part of the Nifty 500 have, on average, lost only as much as the large-caps so far. (see table ‘Across-the-board corrections’)

A look at the trailing valuations puts this trend in perspective (see chart ‘Room for further correction in midcaps). From the October peak, the Nifty’s trailing 12-month PE (consolidated) has corrected from 26 times to about 20 times now. While the valuation of the mid-cap index too has corrected and narrowed the gap with the bellwether, it continues to be at a premium. This indicates more room for corrections here. While smallcaps have seen sharper falls at an aggregate level so far, but as in every downturn, they remain the most vulnerable to further corrections.

Sector rotation

The valuation compression at the headline level has percolated down to the broader markets as well, with more stocks now trading in the lower bands, going by their trailing PEs (see table ‘Valuations take a beating’). Two trends have been at play in the last few months here. One, fancied stocks and segments following the Covid outbreak, whose valuations catapulted, are retracing their steps. Two, stocks which are usually in the high valuation zone have also been punished.

Take diagnostics, for instance. Dr Lal PathLabs, Thyrocare and the recently-listed Vijaya Diagnostics are all over 40 per cent down since October and their valuations have moderated by 37-55 per cent since then. The specialty chemicals segment, which re-rated based on tailwinds such as growing demand, China +1 strategy and capabilities to offer value-added products, is another segment where stock prices and valuations have taken a sharp hit.  The Nifty IT index is among the biggest losers (down 23 per cent). Expensive mid-cap IT players have all corrected 30-40 per cent now with valuations, in many cases, moving down 40-50 per cent. Similar is the story with the much-touted plays on retail investors who entered the market in droves after the Covid outbreak – AMCs, brokerages, exchanges and depository participants.

Among segments that are always in the high valuation zone, FMCG, despite being a defensive play during market uncertainties, was not spared. Headwinds to earnings from costly inputs to inflation as well as high valuation of stocks in this segment saw large-caps such as Hindustan Unilever, Godrej Consumer and Dabur fall over 20 per cent. HUL now trades at 55 times vs 75 times in October. Valuation of Dabur, Godrej Consumer, Marico has moderated too. Paints and consumer durables/appliances - another high valuation segment - also came under heavy shelling. Amber Enterprises, Indigo Paints, Berger Paints are examples of stocks which witnessed PE compression.

A look at those that are relatively unscathed or even gained in this period of broader market correction shows that sector rotation has clearly come into play. Auto stocks are back in vogue with chip shortages beginning to ease and SUV and truck sales showing good traction. The Nifty Auto Index has contained losses much better than the Nifty, dropping only by 2 per cent. Ashok Leyland, Eicher Motors, for instance, are down only in mid-single digits, while Maruti Suzuki and M&M have been gainers. With the Indian economy expected to be in better shape than key global ones, many engineering/capital goods and logistics stocks have also gained in this period.

Earnings picture

Given that over the long-term stock prices catch up with earnings, the ongoing correction and prospects need to be seen in the light of the earnings picture for FY23. When we last wrote on the market correction in March, Nifty EPS for FY22 was estimated (Bloomberg consensus) at ₹732. With the full impact of higher input prices from the Russia-Ukraine standoff not felt, the actuals were better at ₹771, growing 46 per cent over FY21. With earnings doing a strong catch-up in the last two years (see chart ‘How Nifty earnings have moved’), the Nifty PE (consolidated) is now at about 20 times, in line with its 15-year average (since global financial crisis) and at a premium to the 20-year average (includes period prior to QE/central bank stimulus – which is the phase we are entering currently) of 18.8 times.

For FY23, the estimates (Bloomberg consensus) stand at ₹884, indicating a likely 14.6 per cent growth. Domestic brokerage house Motilal Oswal projects a 17.6 per cent EPS growth for Nifty in FY23, while Bank of America, in a report released last week, indicates a 15 per cent growth. But there is downside risk to these estimates. First, the full impact of the Russia-Ukraine crisis is expected to play out in the first two quarters of this fiscal. While some commodities including oil have cooled off in recent times — global growth concerns being one of the reasons — the trajectory remains unclear.

Besides, low interest rates have been a driver of India Inc’s earnings in the last two fiscals and this tailwind will also cease from now on. The impact of high inflation and rate hikes on domestic demand is also a monitorable.

Opportunities for investors  

While no one can predict earnings as well as the market trajectory with accuracy, at this juncture, investors can make use of opportunity provided by the correction in a few ways:

If you prefer taking the mutual fund route, considering the across-the-board correction, index/ETF investing is an option worth considering to take advantage of the fall. Funds based on the Nifty/Sensex, Nifty 100 and the Nifty Midcap 150 are good picks. At BL Portfolio, we have recommended such options right from the early part of this year when market volatility threw up opportunities. Averaging through SIPs in case of index funds or ETF investing in few tranches rather than at one go is a sensible idea, given the volatility and the fact that corrections may not be over yet.

For direct stock investors, the strategy to adopt should be two fold : one, playing on sector rotation and two, looking for value. When doing this, large-caps should top your pecking order. Approach mid and smallcaps from a bottom-up perspective.

Among the in-vogue sectors, select auto OEMs and auto component suppliers with high pricing power and low debt can be good bets. Given the ongoing rotation in favour of stocks which present a proxy play on domestic economic growth, corporate lenders such as SBI, ICICI Bank, HDFC Bank which have seen valuations moderate may present good long-term opportunities. Currently, most gainers from the capital goods space are high valuation stocks such as Thermax, Siemens, Cummins and ABB. But investors can keep tabs for on capital goods space for future opportunities. PNC Infratech has seen valuations moderate further from our earlier ‘buy’ recommendation.

Post the corrections, select pharma/chemical stocks such as Chemplast Sanmar, Zydus Lifesciences, Ajantha Pharma and Caplin Point Laboratories look good value bets today.

With ethanol blending provides long runway for growth for sugar stocks, stocks part of the Nifty 500 basket have hardly corrected. However, a handful of sugar and fertiliser stocks with sound prospects are trading at low PEs. With respect to fertilisers, we have recommended one recently . Mahanagar Gas and CSB Bank can be other value plays.

Staying with the value theme, funds can also be good option to contain downside for investors who prefer the mutual fund route. We have recommended one recently. Ditto with dividend yield funds. In fact, quite a few PSU stocks, which fit both in the ‘value’ and ‘dividend play’ themes, have done quite well in the current downturn. When investing, don’t go all out. Keep powder dry for further volatility or corrections.

COMMENT NOW