Why the Indian Stock Market is Falling

The last few days have been hard for the stock market bulls.

With the exception of traders who were short, everyone's portfolio is in the red. And it's not mainly because of the decline in the Nifty. The real damage has been caused by the crash in midcaps and especially smallcaps.

Largecaps haven't fallen too much just yet in this correction but most retail investors had built their portfolios around midcaps and smallcaps. So it's not surprising to see some amount of panic setting in to the minds of investors and traders alike.

Currently, the losses are not big enough to cause much stress. This is especially because most of them have made a lot of money in the recent market rally. These profits may not have been wiped out yet.

However, if the correction continues, there will be serious losses across the board. In that situation, most portfolios will be deep in the red, just like in the first half of 2022.

So what has caused this decline and what should investors do about it?

Let's examine the answers...

#1 Rising US Bond Yields

The benchmark 10-year US government bond yield holds a special place in the financial world.

It's the most widely held, most widely traded, safe haven asset. It's the one asset that the 'big money' buys when they need safety of principal above all else.

Thus, it's price, i.e. its yield, is the benchmark for all other asset prices in the world. In other words, if money is flowing in the US 10-year bond, it means that it has flown out of other assets.

This is why it's said that the US 10-year bond yield sets the price of all risky assets around the world.

Recently the 10-year bond yield traded above 5%. This is a 16 year high. Historically, whenever the US bond yield rises, stocks in emerging markets like India, tend to fall.

#2 Geopolitical Concerns

The situation in the West Asia looks bleak. The Israel Hamas war shows no signs of ending.

This has raised fears of the possibility of the war spreading across the middle east. This has driven crude oil prices higher. This has added to concerns about inflation as well as wider repercussions on global trade.

During such times, global financial markets are in 'risk off' mode and money flows out of risky assets like stocks.

The risk-on, risk-off trade is a regular phenomenon in financial markets. However, on some occasions, the markets can overreact to an event and can fall significantly.

This is the big fear in the stock market right now, which has caused some investors and traders to sell in anticipation of a crash.

#3 Valuations

While many reasons will be given for this correction, there is one above all else. The market was overvalued and could have fallen with any kind of trigger. The crisis in west Asia just happened to be the straw that broke the camel's back.

Here's what Aditya Vora, our research analyst wrote in the Profit Hunter recently...

• If you look at all the parameters, right from VIX i.e. the volatility index, bond yields, dollar index (a safe haven asset), every possible indicator indicates stress in the global financial system.
  
  Many investors heaved a sigh of relief when the US Fed decided to pause increasing rates.
  
  However, little did they realise that the battle was only half won. The problem is not only rising interest rates but interest rates remaining this high for a long time.
  
  High interest rates even if they are stagnant snowball into high cost of capital when combined with a slowdown could lead to catastrophe.
  
  We investors sitting in India must realise that even if USA sneezes, emerging market countries will catch a cold.
  
  In the end, market movements are all about fund flows. A strong dollar is not what we want for the brightest economy in the world.

What Should Investors do now?

Well if you're a long term investor, it's a good idea to take a look at your portfolio.

There may be stocks that don't deserve to be there. Maybe you bough them for some quick gains. It might be the right time to get rid of them.

Also if you're considering buying stocks now, we suggest reading this article - Is this the Right Time for Long Term Investors to Buy Stocks?

However at the same time, we must state clearly that caution is warranted in this market. There is no guarantee that the market will bounce back quickly. It might but then again, this correction could get worse in a hurry.

Here's what Tanushree Banerjee, co-head of research, believes it's possible for the Sensex to fall to 50,000. Here's what she had to say...

• Although just a scenario, based on few assumptions, it is not impossible for the Sensex to end 2024 lower than where it is today.
  
  Also, it is perfectly reasonable to expect equity investors to be prepared for a very volatile stock market.
  
  The benchmark index tends to sway wildly in a year when several macros are shifting. And 2024 could be such a year for several reasons.
  
  The problem is most investors today aren't even keen to think about it. They would rather see their stocks nosedive, especially the problematic ones, than prepare for Sensex 50,000.
  
  And this not just about the Indian stock markets or Indian investors. The post pandemic euphoria in global stock markets could possibly take a back seat in 2024.
  
  Indian investors may have to contend with some major macro changes in 2024 that could jolt their perception of the stock market risk.

Conclusion

It makes sense to buy high quality stocks during market corrections. However you should be very careful of the valuations when you do so.

Only consider taking the plunge if the margin of safety is sufficient.

If you're trying to get rich quick in this market, there could be bad news in store. Navigating the market through geopolitics and the fallout of rising US interest rates, will be challenging.

It's best to stick with fundamentally strong largecaps in this market. Also have sufficient cash as a buffer for the portfolio as well as dry powder when the market's negative phase ends.

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...