Investors may manage to settle down but valuations will need eventually to catch up fundamentals for all stocks.

After the rout in the stock market on Friday. On Sunday, the RBI and SEBI decided to take appropriate action if necessary.  On Monday, the finance minister tweeted that the government will take all measures to ensure that adequate liquidity is provided to non-banking financial companies, mutual funds, and small and medium enterprises. But none of this helped.

Nifty 500 indexes fell by 1.9% on Monday, in fact, worse than Friday that was 1.3%. And but for a rise in the share price of market heavyweights Tata Consultancy Services Ltd (TCS) and Reliance Industries Ltd, the fall in the market would have been worse.

The point is why the market ignore all reassurances that came its way?

The main reason is that the scare about a liquidity crunch has worked as a trigger for a much-needed correction in the Indian market. As one private equity fund manager put it recently, “India’s equities rally has been a soulless one.” The reference is to the rise in the large-cap indices, despite major headwinds such as the rise in oil prices and the depreciation in the rupee.

On Monday, too, TCS shares rose by about 5% and the Nifty IT index rose by over 2%. Evidently, investors are looking for a safe zone. While their reaction is understandable, what it has done is to increase valuations of these stocks to unreasonable levels. For all the talk of increased demand for IT services, hardly any of the large IT companies are reporting a meaningful increase in growth rates. Apart from that, the gains from the depreciation in the rupee are expected to be temporary as well.

It’s likely that the rally in large-cap indices such as the Nifty 50 which is still up 4.2% a year till date is in its last legs.

Apart from the top few stocks the rest of the marketing is correcting this year. Nifty Next 50 index has fallen 10.5% this year, while the Nifty Midcap index has fallen 15.6% and the Nifty Smallcap index has corrected by 26.1% so far this year.

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