The Nifty Midcap 100 Index has recently hit an unprecedented high of 60,400 driven more by market forces than by robust corporate fundamentals. Currently, the index trades at a Price-to-Earnings (P/E) ratio above 44 — the highest level since the post-pandemic surge in midcap stocks. This P/E multiple is significantly above its 5-year and 10-year median levels, by approximately 75% and 54%, respectively, signalling that midcap stocks are trading at a considerable premium.

These inflated valuations raise concerns about an impending market correction. Historically, when the Nifty Midcap 100 has experienced a sharp decline of 10% or more in a single month, the Nifty 50 has consistently outperformed both the Nifty Midcap 100 and Nifty Smallcap 100 indices.

Statistical data shows that when the Nifty Midcap 100 rallies more than 15% over four months and subsequently corrects, the Nifty 50 has a higher probability of outperforming both the Midcap 100 and Smallcap 100 in the following month which is displayed below.

For instance, Nifty Midcap 100 rallied for 27.5% from January to April 2006 and subsequently declined by 14% in May 2006. In such a scenario Nifty 50 posted a return of more than 1.5% in June 2006 whereas Nifty Midcap 100 and Nifty Smallcap 100 posted negative returns during the same period. The table below displays similar instances that occurred in the past and the performance of these indices after the decline.

The Nifty Mid Cap 100 has rallied by over 15% between May’24 and August’24. If the index closes at levels of 59,200 – 59,250 or lower by the end of September, the likelihood of it following the aforementioned trend increases, making large-cap stocks more appealing relative to midcaps and small-caps.Supporting this shift, recent data from the Association of Mutual Funds in India (AMFI) highlights a growing preference for large-cap equities. In August, large-cap funds recorded net inflows of Rs. 2,638 crores – a 300% increase over July’s inflows, marking a fourfold surge. This trend underscores the increasing appeal of large-cap stocks as a defensive strategy in a volatile market environment.Moreover, historical patterns suggest that when large-cap funds experience a threefold increase in net inflows or transition from net outflows to inflows, the Nifty 50 has outperformed the mid-and small-cap indices in the second month following these inflows. This trend, observed consistently over the past five years, highlights the critical role of fund flow dynamics and timing in market performance.

For instance, if large-cap fund inflows in August tripled compared to July, Nifty 50 returns in October generally outpace those of the mid-cap and small-cap indices.