Midcap Mania or Meltdown? Jefferies Issues Warns Valuations Concerns in Indian Markets

India's stock market rally is making new highs, but global brokerage house Jefferies has sounded a sharp warning: valuation issues are back, and the midcap space is front-running the charge into risky territory.

With the latest Jefferies report citing that the benchmark Nifty index has risen 14.1% since April 7, elevating its 12-month forward P/E to 22.2, it's actually the midcap stocks that are making headlines—and not for a good reason. The Nifty Midcap 100 index has risen 23.7% since then and is trading at a shocking 27.1x forward earnings, way above historical levels.

The rally in the market has made valuations a problem once again, more so in the mid-cap segment," Jefferies said in the report.

Equity Supply Surge

The sky-high prices haven't escaped India Inc.'s attention either. Firms have rushed to raise new equity, riding the optimistic tide. A total of $7.2 billion has been raised during equity issues last month alone, and another $6 billion has already been raised in June—a total of more than $13 billion in just two months, says Jefferies.

This surge of supply, Jefferies opines, poses the largest threat to market stability. For perspective, equity supply in monthly terms prior to the September 2024 market downturn was similarly about $7 billion—levels currently being met and surpassed.

Market Rotation: Capex Out

It also reflects a discernible post-Budget shift in investor taste, away from investment-driven themes such as infrastructure and manufacturing, and to consumption-driven sectors. The Reserve Bank of India's softer monetary policy has also served to accelerate the trend, and consumer finance and retail-driven stocks have benefited.

But Jefferies cautions that the next cycle is set to be sluggish and conservative. In contrast to FY03-FY17 when there was a capex boom followed by over-capacity in industries such as power, this cycle is likely to be a gradual one, capping near-term tailwinds in investment themes.

Outlook: Rally with Risks

As investors still bask in the euphoria, Jefferies' red warning on valuation excess and frothy equity supply is a reminder that euphoria tends to end in corrections. For the retail investor and institution alike, the big question now is: Is this a sustainable growth story—or the beginning of a midcap meltdown?

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