Why experts fear that NSE 500 index has become overheated

Liquidity gush, the advent of new investors, and hopes of the economy coming out of the onslaught of the pandemic have been moving the markets.

More than 90 per cent stocks in the NSE 500 universe are currently trading above their 200-day moving average (DMA).

Experts say this is a sign that the market has become overheated and can lead to a correction or sideways movement for a long period.

The 200-DMA is a key technical indicator used by traders to get a sense of market direction.

A level, which is roughly a 40-week average, often acts as key support or resistance.

While a stock trading above its 200-DMA is usually considered to be in a bullish zone, such a large majority of stocks trading above this level can point to overheating.

“In the NSE Nifty 500, 95 per cent of stocks are trading above their 200-day moving average —the most since the 2014-15 upcycle and the recovery after the 2008 global financial crisis.

"About 40 per cent NSE Nifty 500 stocks have posted one-year returns of more than 100 per cent, the highest in the past decade.

"Such torrid growth was last seen during the 2009 recovery, after which the markets traded sideways for almost four years,” said Gaurav Patankar, head-emerging market strategy, Bloomberg Intelligence, in a recent note.

Both Sensex and Nifty made fresh highs on an intraday basis last week.

The Sensex for the first time breached the 53,000-mark before settling lower.

Except for Hero MotoCorp and Kotak Mahindra Bank, all the Nifty50 components are currently trading above their 200-DMA.

“The daily moving average (DMA) moving up is a sign of the markets getting overheated.

"Liquidity gush, the advent of new investors, and hopes of the economy coming out of the onslaught of the pandemic have been moving the markets,” said G Chokkalingam, founder, Equinomics.

HFCL, Adani Enterprises, Venky's India, Lux Industries, and Adani Total Gas are some of the stocks that are trading way above their 200-DMA.

Another 50 stocks from the Nifty 500 index are trading at least 50 per cent above their 200-DMA.

“Many stocks trading above their long-term averages is not surprising considering the surge in the market in the past year.

"This shows that the market has a bullish trend.

"Q4 earnings have been good; reopening of the economy and ramp-up in vaccination drive investor optimism.

"And the global economy is in its best shape in years.

"Demand for crude oil is rising, which means the global economy is bouncing back.

"The surge in the markets is going to continue as more Indian states ease restrictions.

"Only a hike in US interest rates can throw a spanner in the works as far as the markets are concerned,” said Siddhartha Khemka, head of retail research, Motilal Oswal Financial Services.

There are several other factors, such as a surge in price-to-earnings and price-to-book multiples, the relentless surge in micro-caps and a retail frenzy, that are pointing towards a disconnect between the fundamentals and stock prices.

However, the market may be looking for an external trigger to correct.

“The factors that trigger such a fall can be a global factor like a sooner-than-expected hike in US interest rates or disappointment over the economy not bouncing back enough from the pandemic induced setbacks.

"Overvaluation could be another reason.

"This time, I feel, small- and mid-caps can trigger the fall. Small and mid-caps were always one or two theme-driven.

"This time so many sectors have gone up within the mid and small-cap universe.

"Whenever mid- and small-caps have outperformed the index by a huge margin, it was followed by an equally steep correction,” added Chokkalingam.

Photograph: Danish Siddiqui/Reuters