The recent market correction has cooled valuations of headline indices somewhat.

The benchmark Nifty is down 14 per cent from its September highs and now trades at a one-year forward price to earnings multiples of 18.6x, 9 per cent below its long-term average. In the past, Nifty’s forward P/E has dropped to 10.5x and 15x during the global financial crisis of 2008 and the pandemic-induced crash in early 2020.

India’s market cap-to-GDP ratio has fallen to 120 per cent from 146 per cent in September last year.

Midcaps and smallcaps, however, continue to trade at a 22 per cent and 25 per cent premium, respectively, to their long-term historical averages, highlighting the risk of further corrections if earnings fail to catch up.

“Given the current market environment, large caps offer better downside protection and more reasonable valuations, making them the preferred bet,” said a note by Motilal Oswal Financial Services.

The brokerage believes that sectors such as BFSI, consumption, and healthcare offer attractive opportunities, while cyclicals such as automobiles, metals, and cement may remain under pressure from input costs and weaker demand. “The correction, while painful, is creating selective accumulation opportunities. Investors should focus on stocks with strong earnings visibility and stable cash flows,” it said.

Activity in cash markets has moderated in recent months, with the retail cash average daily volumes declining to about ₹300 billion from the peak of ₹500 billion. Cash delivery volumes has come off its peak as well.

Headline valuations, however, could be misleading, said a note by Kotak Institutional Equities. The brokerage, which does not find value in most parts of the market, feels consumption stocks are trading at full-to-frothy valuations, given short-term growth issues and medium-term disruption risks, while investment and outsourcing stocks are trading at fair-to-full valuations.

The key downside risks for the market are a sharper-than-expected global slowdown, sustained FPI selloff, a weak monsoon and a dip in retail flows into equities, especially into small and mid-cap funds.

Any underperformance or profit shortfall could lead to volatility for overvalued companies, said Kenneth Andrade, Director, Old Bridge Capital Management, adding that global investors could divert some capital away from India to destinations such as China and Europe, which were relatively undervalued.