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    Why stock investors should be cautious in extended bull runs like this one

    Synopsis

    The Nifty Smallcap 100 index often returns to its mean after extended bull runs, similar to the Nifty 50. The index has retraced to its 200-day moving average five times since 2016. Investors should be cautious of short-term corrections post-bull run and adopt a balanced approach.

    Jimeet Modi

    CEO, Samco Ventures

    Modi believes that price is the most important factor in investing. He is credited with developing t...Show more »

    In my previous article, I wrote how the Nifty 50 index often returns to its mean after an extended bull run. It’s much like a stretched rubber band that eventually snaps back. If we apply the same concept to the Nifty Smallcap 100 index, we can see similar patterns. Even though the small-cap stocks are highly volatile, they gravitate towards their mean over time.

    Small caps have gained attention during the bull market over the past year, but investors should understand the concept of mean reversion. This helps them remain cautious, identify opportunities, and maintain a balanced approach to risk and reward, aiding in better decision-making during market pullbacks.

    In the Nifty Smallcap 100 chart below, we can see that the index has retraced to its 200-day moving average line five times since 2016. After each bull run, the index pulls back to this key support level or consolidates near it before resuming its upward trend. This highlights the significance of mean reversion in identifying market trends, especially during extended bullish phases.

    ChartETMarkets.com

    The chart below highlights the Nifty Smallcap 100 index’s streak of closing above its 200-day moving average (DMA). Between 2004 and 2024, the index has managed to close above this level for over 100 consecutive days on nine occasions whereas it has recorded a streak of over 200 days in seven instances.

    Growfast
      Chart 2ETMarkets.com

      The table below showcases the longest streaks of the Nifty Smallcap 100 index staying above 200-day moving average for over 100 days, and the returns delivered by the index during these periods. The longest streak occurred between 2004 and 2006, lasting 411 days with a 120.94% return. The ongoing streak since April 2023 has already extended to 344 days, yielding a return of 103.39%.

      The forward return analysis in the table reveals that while the Nifty Smallcap 100 index has posted impressive gains during extended bullish phases—ranging from 7.49% to 120.94%—it is often followed by short-term corrections. This is reflected in the negative average returns over 1- and 3-month periods.

      Just as a rubber band snaps back with greater intensity when stretched, small-cap stocks, known for their high volatility, tend to experience sharp declines after prolonged upward trends. Furthermore, the negative returns shown are calculated from the point where the index closes below its 200-day moving average, meaning the pullback from the peak to the 200-DMA level is in addition to the corrections listed in the table.

      Chart 3ETMarkets.com

      The chart below compares the performance of three indices: Nifty Smallcap 100, Nifty Midcap 100, and Nifty 50, over a period from 2010 to 2024. Small-cap and mid-cap stocks, being more growth-oriented tend to outperform the large-cap stocks represented by the Nifty 50 during bullish phases, as seen in the chart. This often results in a significant gap between the performance of these indices compared to the Nifty 50. Eventually, these indices tend to converge due to mean reversion. In essence, when the market corrects or stabilizes, midcap and smallcap stocks often undergo sharper corrections, bringing their performance closer to that of large-cap stocks.

      Chart 4ETMarkets.com

      Considering the above points revolving around mean reversion, investors should remain cautious in expecting consistent short-term gains post a bull run. They need to adopt a balanced approach, recognizing the risks of post-streak corrections and making informed decisions to navigate through the potential volatility that lies ahead.


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      (Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)

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      (You can now subscribe to our ETMarkets WhatsApp channel)

      (What's moving Sensex and Nifty Track latest market news, stock tips, Budget 2024 and expert advice, on ETMarkets. Also, ETMarkets.com is now on Telegram. For fastest news alerts on financial markets, investment strategies and stocks alerts, subscribe to our Telegram feeds .)

      Subscribe to The Economic Times Prime and read the Economic Times ePaper Online.and Sensex Today.

      Top Trending Stocks: SBI Share Price, Axis Bank Share Price, HDFC Bank Share Price, Infosys Share Price, Wipro Share Price, NTPC Share Price

      ...more
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