Mumbai: Public sector undertakings (PSUs) led the sell-off in mid-cap and small-cap stocks on Friday as investors are increasingly judging that many of them are overheated after their recent run-up.

The Nifty Small-cap 250 dropped 1.3% and the Nifty Mid-cap 100 declined 0.9%, while the Nifty Public Sector Enterprises (PSEs) index slipped 2.7%. All three indices erased a portion of the losses earlier in the trading session tracking the rebound in the benchmark indices – Sensex and Nifty, which ended 0.3% higher.

Nifty Small-cap 250 fell as much as 2.75%, Nifty Mid-cap 100 sank as much as 2.6% and the Nifty PSE slumped as much as 5.1% earlier on Friday.

Analysts said a correction was imminent in the PSU stocks after the sharp rally in the past couple of months.

“Most PSU stocks are at expensive valuations and have run up significantly in the past one year,” said Sandeep Raina, executive vice president-research, Nuvama Professional Clients Group. “A correction of 10-15% post a sharp rally is normal and the long-term outlook remains positive.”

Out of the 3,932 stocks traded on the BSE, 2,573 stocks declined, while 1,270 advanced.Shares of Power Finance Corporation slumped 8.45%, while REC and NHPC fell over 5%. Shipping Corporation of India slumped 6.72% and Rail Vikas Nigam declined 7.99% on Friday.”PSU stocks have witnessed a very sharp rally in the past couple of months,” said Sneha Poddar, associate vice president- equity research, Motilal Oswal Financial Services. “The re-rating in these stocks has already taken place which has led to profit booking.”

Poddar said elevated oil prices due to the Red Sea crisis and the hawkish stance of the US Fed and the RBI have also contributed to profit booking in the midcap PSU space.

In the past three months, the Nifty PSE index surged close to 48%, while the Small-cap 250 and Mid-cap 100 indices rose about 21%. Analysts said the rally in public sector stocks has led to a surge in participation by individual traders, who have mounted bullish bets on them with borrowed money.

Raina said the Relative Strength Index (RSI) indicator for most PSUs was at 80, which is very high. A high RSI level indicates that the stock is at an overbought level.

Analysts said third-quarter results of some PSU companies may be pointing to stretched share valuations.

“The recently declared results yesterday of PFC were reasonable but not excellent,” said Raina. “The stocks are closer to their highest price to book valuations and the earnings didn’t match up the one-sided run-up.”

Analysts do not anticipate a reversal in the long-term bullish trend in PSUs.

“A further correction of 10-15% is likely but there is still room for upside movement in the long term,” said Raina. “This is because the efficiency of PSUs has gone up and the size of opportunity from the government is big.”

Poddar said that the fall would be limited since the order book and business outlook of the PSUs remains strong.

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