Indian Share Markets Could Face These 3 Big Risks in 2024

The recent correction in the market caused some concern among investors and traders.

And that's understandable. Most people in the market are looking to speculate and suffered losses. There's nothing wrong about speculation. We at Equitymaster are not against it.

However, this approach creates a level of volatility in the market that few can handle with a calm mind.

It also causes anxiety about the actions of others. If you choose to hold while others sell, you will end up selling at a lower price. This creates fear which itself becomes a driving force behind stock prices.

And there was a genuine sense of fear in the stock market last week.

So, could the markets go down further? This has become a popular question in the markets recently.

In this editorial, we will examine the top 3 risks the Indian stock market faces this year.

#1 The Upcoming General Election

Now most people have concluded that the ruling dispensation will be the top choice of the Indian voter. The media and pollsters think the same way.

This should be good news for the market. In fact, a continuation in government should create a sentiment in the market that is the opposite of fear.

However, things are not so simple. Those who are old enough to remember the 2004 election, will tell you not to be overconfident. The shock of a change in government is a very real concern for the bulls.

It's one thing that the government is expected to return to power comfortably. But achieving that is another thing entirely.

In fact, the argument in favour of this being a risk for the market is very simple. Everyone expects the government to return to power. So, the bet is unidirectional in the market. Almost no one is on the other side of the trade.

This means if something adverse were to happen on counting day, everyone will try to sell at the same time. This massive rush for the exit will likely cause a crash reminiscent of the May 2004 crash.

Now, the good news here is that the market will recover no matter what happens with the election results. Even if the government changes, the markets will recover sooner than most people expect. One look at the speed of the market's recovery after the 2004 election results should provide comfort.

This is because of India's long-term economic growth prospects. As long as India keeps getting richer, the markets will go higher.

#2 Interest Rates and a US Recession

We have a possibility of the slowdown in the western world leading to a recession.

This is a concern but as long as the US stays out of a recession, there won't be too much pressure on the Indian market. Right now, the US economy appears to be resilient. However, things could change as the year progresses.

Next is the threat of interest rates staying high for longer than the markets expect. Central banks have made it clear that they want to control demand to the extent that it brings inflation under control.

Now, this should be achievable helped by falling commodity prices. But at the moment, no one is sure how much of a slowdown is needed to bring inflation fully under control.

The fear is that if the slowdown is serious enough, the US might tip into a recession later this year just as inflation comes under control.

Sure, the US Fed will then cut rates, which will be positive for the market, but by then we could see a serious correction before the market recovers.

While this is a possibility, especially in an election year in the US, Indian investors and traders should not be too concerned about it. Even if FIIs get spooked due to these reasons, they will return to the Indian market as they always do.

#3 Valuations

This is probably the most important risk for the market.

We believe, the main reason for a correction in the market in 2024 will the ongoing bull market itself.

Yes, that's right. The bull market itself will cause a serious crash. This crash could even turn into a bear market if it's accompanied by a US recession in 2024.

But why do we say this?

Well market veterans know something that most investors either never realise or understand only after a big crash or bear market.

Huge losses in the stock market are almost always because retail investors ignore either the fundamentals or valuations (or both) of the stocks they buy.

In other words, retail investors fall prey to the following mistakes.

• They buy low quality stocks or stocks with big risk factors and think they would be fine in the long term due to the company's growth prospects playing out.
• They buy highly overvalued stocks, like high PE stocks, and think it wouldn't matter in the long term because the expected price appreciation.

What many retail investors fail to realise is that a rising market makes them feel these mistakes don't exist. This is because rising stock prices hides these mistakes. Rising prices create the illusion that investors have made the right decision.

This prevents retail investors from selling junk stocks at the right time. They hold on to them expecting ever higher returns, convinced they have made a good choice buying that particular stock.

You see, the higher the market rises, beyond what is justified by earnings growth, the riskier it becomes to have money in the market. This is measured by the humble PE ratio.

The Nifty's PE was close to 25 at the time of the correction. Market veterans will tell you, this number, 25, is sort off a thumb rule for thinking about risk and caution in the Indian stock market.

If the PE rises above 25, it's time to worry. As the market rises towards this number, it makes sense to increase your level of caution and vigilance.

This will be the main reason for a market crash in 2024 if it happens. The trigger - an adverse election outcome, a recession in the US, a war, a banking crisis, or anything else - will be the justification.

Conclusion

So, what should you do if there is a correction?

Well, a clean-up of your portfolio could be in order.

Here are some things to look for in your portfolio...

• Check for any junk stocks.
• Check for any stocks with negative changes in the fundamentals.
• Check for stocks where valuations have shot up without an improvement in earnings.
• Check for stocks in which you have made a mistake in your original analysis.
• Check for stocks where the price has shot up without much of a change in the fundamentals.

These are all good reasons to sell or at least reduce your holdings.

But as is the case with any stock, you must allocate sufficient time to do the necessary due diligence. This is true both, before and after buying it.

Happy investing.

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. Learn more about our recommendation services here...