Markets

More stocks slip below 200-DMA, is the market headed for a correction?

Stock markets are at historic highs, but a closer look reveals that the number of stocks above their long-term averages has been coming down, pointing to an imminent correction, says a section of analysts.

An analysis of the A-group stocks reveals that the number of stocks above 200-day moving average (DMA) has come down to 70 per cent at the end of the June quarter from 82 per cent at the end of the March quarter, said Rohit Srivastava, fund manager, Sharekhan by BNP Paribas.

When an index or a stock closes below the 200-DMA, it is said to be in a long-term downtrend, and it signals that a new buyer of the index or a stock is willing to pay less than the average price paid in the past 200 trading days.

Since 200-DMA is a long-term average, it is considered a major support level for an index or stock. There are roughly 200 trading days in a year after deducting holidays and weekends so basically it gives a yearly trend.

According to Srivastava, the fall in the number of stocks above 200-DMA has in the past acted as a precursor to a correction in the market. Currently, Indian markets are up 22 per cent for the year, with valuation on a trailing basis at 23.6 times — the highest in seven years. As of Wednesday, 79 per cent of the A-group stocks were above 200-DMA.

“It shows a loss of momentum as the number of stocks participating at each new high is fewer. Typically, one or two quarters of such an indication has led to a correction in the markets,” Srivastava said, adding, “In September last year, before the market peaked around 8,900, we had a decline in the data even though the index was higher. We have seen the same happening in the June quarter.”

If one analyses the listed liquid stocks (analysis of stocks with 30-day average volume of 10,000 shares and a minimum price of Rs 10), then of the 1,230-odd companies, the number of stocks above 200-DMA stood at 57 per cent, down from 68 per cent at the end of March quarter.

The current market valuations have made investors’ wary on how long the rally can last. “The current all-time high Nifty valuations can be justified only if we presume double-digit growth in perpetuity. We maintain our view of a muted near-term macro/earnings recovery in India and continued earnings cuts, making the risk-reward unattractive at these levels,” said brokerage UBS in a note. However, some believe that even though there are signs of fatigue in the market momentum, a significant correction is unlikely.

“The momentum is not strong at higher levels but at the same time, there is no indication of a trend reversal on charts. We are likely to see 10,200 before any correction and any decline is likely to be restricted to 9,900,” said Nagaraj Shetti, senior technical analyst at HDFC Securities.

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