Why the Indian Stock Market is Falling

Just a couple of weeks ago, it seems the Indian stock market would scale new highs.

After all, the Nifty had achieved a new all-time high and there was speculation of a trade deal being signed between India and the US.

But sentiment has changed recently. The Nifty seems to be struggling around the 26,000 mark.

Nifty - 1 Month

Is this a temporary phase before a bull run or is there cause for concern?

In this editorial, we dive into the reasons for the recent correction.

Read on...

#1 Dashed Expectations

When the Nifty made a new all-time high, the market was not worried about earnings growth of corporate India. This was because Dalal Street expected aa recovery.

The two main reasons why earnings growth was subdued were, the slowdown in domestic consumption and the uncertainty caused by Trump's tariffs.

The market convinced itself that the GST cuts would mostly solve the first problem, given enough time.

On the tariff front, a trade deal seemed to be close at hand.

However, both these expectations are looking shaky. Earnings growth hasn't shown signs of a recovery - it might do so in results season in January but we will have to wait and see - and there is no news of a trade deal. In fact, Trump has now threatened Indian rice imports with tariffs.

#2 Valuations are Hard to Justify

The point above has brought Dalal Street's focus back on valuations.

Now, the Nifty is not expensive. It's PE ratio of about 22.6, while slightly on the higher side, is still in line with historical trends. It's only when the Nifty's PE crosses 25 that market veterans begin to worry.

That will happen only when the Nifty gets close to 30,000 or if earnings turn negative, which is unlikely.

But the important point is that high valuations can be justified only with high earnings growth. The problem with expectations of high growth is that eventually, those expectations have to be met.

If they're not met, valuations will correct due to a fall in prices. We have seen this in the broader market of midcaps and smallcaps already.

As investors have woken up to the fact that many midcaps and smallcaps were being priced irrationally, they began to sell. The lack of strong earnings growth was just the trigger.

Thus, money moved out of these stocks and into largecaps. This has supported large-cap stocks to an extent, but the question remains...what happens if investors start selling largecaps too?

Investors will have to keep a close eye on the next quarter's earnings.

#3 Uncertainty About US Fed Policy

Global markets are convinced that the US central bank will cut its interest rate by 0.25% at its 10 December meeting.

However, there is no clarity about any more rate cuts.

Stock markets like rate cuts as it results in more money flowing out of safer assets like bonds and in to riskier assets like stocks.

Global markets expects the US Fed to cut interest rates a few more times in 2026. However, there is now uncertainty on that front.

If the US Fed does not provide any guidance about further rate cuts at the upcoming meeting, there could be an adverse reaction in global stock markets, including India.

A part of the recent selling is in anticipation of possible negative news on this front.

Conclusion

Equitymaster, has been in the market for over 30 years and there is one thing we know for certain:

No one can predict the future and more importantly, no one should attempt to do so. We strongly believe that time in the market is far more important than timing the market.

In the long term, the Indian stock market will go up along with the Indian economy. We have even made a Sensex 100,000 by 2027 prediction.

But that's based on earnings growth, not sentiment.

Instead of trying to anticipate or react to every small move in the market, a better thing to do would be to make a watchlist of high-quality stocks and act on them when valuations become reasonable.

Do your due diligence. Consider factors such as valuation, industry trends, corporate governance, and market risks before making any investment decisions.

What about the stocks already in your portfolio?

In this uncertain environment, if you are concerned about the stocks in your portfolio, then ask the following questions...

• Are the company's fundamentals weak?
• Has there been any recent negative changes in the company's fundamentals?
• Did the PE ratio shoot up without an improvement in the company's earnings?
• Did you make a mistake in your original analysis at the time of buying?

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.

If the answers to the questions above is a clear 'NO', then you can consider holding on, especially if the valuations are not too expensive.

And if the fundamentally strong stocks on your watch become available at reasonable prices, i.e., a low valuations, then you can consider them.

The best stocks to invest in right now - as long as the fundamentals are strong - are the ones that have suffered a correction of some sort for sentimental reasons.

These reasons should be short term in nature - tariff concerns, margin pressures, a cyclical slowdown in its industry, etc.

As long at the core fundamentals of the business are fine, investments can be considered at reasonable valuations... even if the stock market is falling.

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...