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The capital goods sector was the centre of attraction last year, flaunting impressive numbers and catching the attention of many investors. Before enthusiastically diving into what looks like a great chance to make money, it is important to be cautious. For the year ended December 31, 2023, the S&P BSE Capital Goods Index experienced a remarkable surge of 66.89%, outpacing the Nifty50 and Sensex by considerable margins.

This exuberant growth may spark excitement, but beneath the surface lies a market that might be getting a bit too frothy for comfort. Overconfident investors, perhaps overlooking essential market fundamentals, have contributed to pushing the prices of securities well beyond their intrinsic values. In this article, we will explore three reasons why caution should be taken by investors eyeing the capital goods sector.

Rich Valuations

As of January 24, 2024, the S&P BSE Capital Goods index had a PE ratio of 48.31 (Source: Trendlyne). Many companies within the capital goods sector are showing PE ratios that go well beyond their 10-year average. This indicates the high valuations of some companies compared to the overall index. Companies having excessively high PE ratios have little margin of safety. There is a high probability of a fall in prices if the expected growth doesn’t materialize.

Excessive Speculation

A key metric that can be used for gauging market perception is the ratio of turnover to market capitalization. This ratio is calculated by dividing the total turnover of a stock over a specific period by its market capitalization. So if the turnover of a company’s shares is greater than its market cap then it means that people are not holding on to the company for too long. They are churning the stock more often. The stock is in the hands of speculators rather than investors.

Several companies in the S&P BSE Capital Goods index have high turnover compared to their market cap. This indicates the entire sector is in the grip of speculators rather than investors at the moment.

Reversion to the Mean

Jimeet Chart 1Agencies

With a staggering surge of 66%, the S&P BSE Capital Goods Index has undeniably been the star performer in 2023, marking its most significant surge in the past decade. This stellar performance outpaced major indices, further fueling the excitement around the sector. However, it would be naïve to think that the sector will deliver similar returns in 2024. This raises concerns also because the sector’s current valuations is currently at its peak. Investors looking to add capital goods stocks to their portfolios must balance enthusiasm with prudence, and a wise move is to wait for a correction before they can enter.

Technical Outlook:

Jimeet chart 2Agencies

In the weekly wrap, Nifty concluded at 21,353 marking a 1.02 % decline.

Sectorally, Nifty Media, Realty, and FMCG were the top underperformers. Despite persistent attempts to breach crucial resistance, each effort resulted in a sell-off. The Nifty oscillated in a broad range of 21,138 to 21,750 levels.

Technically, the Nifty has formed consecutive bearish weekly candles falling nearly 3.5% from its all-time high of 22,124.

In the daily chart, the RSI remains weak, staying below the average level of 50. The index has fallen below the 20 DMA and holds minor support at the 50 DMA. However, weekly support stands firm at 20,770 followed by 20,500 levels while the upper Bollinger band poses resistance around the 21,750 zone.

In January until the 24th, Foreign Portfolio Investors (FPIs) offloaded equities worth Rs. 33,634 crores, while Domestic Institutional Investors (DIIs) purchased equities amounting to Rs. 16,502 crores, this indicates a discernible shift in change in trend.

As Budget 2024 approaches, various sectors are experiencing momentous upheaval with volatility, as evidenced by the rising India VIX.

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