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The Indian stock market has been experiencing a persistent decline since September of last year, sparking widespread apprehension among investors and market analysts. The benchmark indices, Sensex and Nifty 50, which primarily track large-cap companies, have witnessed a significant erosion in value, shedding approximately 14% over the past five months. While this downturn is undoubtedly concerning, it's crucial to contextualize it within the broader historical perspective of market corrections. Compared to the precipitous drops observed during the 2008 financial crisis, where large-cap indices plummeted by a staggering 64%, or the abrupt collapse triggered by the Covid-19 pandemic in 2020, which saw a 40% decline, the current correction appears relatively moderate in magnitude. Even previous market corrections in India, such as those in 2010 and 2015, resulted in more substantial declines, exceeding 20% from peak levels. This historical context suggests that the ongoing correction, while unsettling, is not unprecedented and falls within the realm of typical market fluctuations. Market corrections are an inherent part of the stock market cycle, characterized by alternating periods of rallies and subsequent declines. These downturns serve a vital purpose: to eliminate the speculative excess, or "froth," that accumulates during prolonged bull runs. A bull run, characterized by sustained price increases, often attracts speculative investments driven by short-term profit motives rather than sound fundamental analysis. This speculative activity can inflate asset prices to unsustainable levels, creating a bubble that is prone to bursting. Market corrections act as a natural mechanism to deflate these bubbles, forcing investors to re-evaluate their positions based on underlying fundamentals rather than speculative hype. The current correction can be attributed to several factors, including the withdrawal of funds by foreign portfolio investors (FPIs) due to concerns about slowing corporate profitability in India, the weakening of the Indian rupee against other major currencies, and the potential negative impact of geopolitical events on the Indian economy. However, the Indian stock market's underperformance compared to other global markets can also be attributed to profit-booking by domestic institutional investors (DIIs), who capitalized on the substantial gains accumulated since the pandemic-induced market recovery in 2020. The Indian stock market has indeed been a standout performer since the onset of the pandemic. While other emerging markets grappled with severe declines in the aftermath of the Russia-Ukraine conflict in 2022, the Indian market demonstrated remarkable resilience, staging a swift recovery and embarking on a period of robust growth. This strong performance was fueled, in part, by a surge in participation from retail investors, with an estimated seven crore new individuals entering the stock market during and after the pandemic. The influx of new investors, eager to capitalize on the market's upward trajectory, led to increased activity in riskier segments of the market, such as penny stocks (stocks with low prices and questionable fundamentals), stocks listed on the SME (Small and Medium Enterprises) platform, and initial public offerings (IPOs). These segments often attract speculative interest due to the potential for quick gains, but they also carry a higher risk of losses.
The rapid increase in retail participation also contributed to a surge in trading volumes in equity futures and options, which have been doubling every year since 2020-21. This increased activity, coupled with strong inflows from domestic institutional investors, propelled India to become one of the most expensive equity markets globally. As a result, the price-to-earnings (P/E) multiple of the Nifty 50 index, a widely used valuation metric, rose to a high of 24 in September 2024. While the ongoing correction has brought the P/E multiple down to around 20, it still represents a significant premium compared to other emerging market indices, suggesting that Indian stocks remain relatively overvalued. Furthermore, valuations in certain sectors, such as fast-moving consumer goods (FMCG), multinational corporations (MNCs), and consumer non-durables, remain at exceptionally high levels, indicating that these sectors may be particularly vulnerable to further corrections. Given the still elevated valuations in the Indian stock market, the current correction is likely to persist until prices align more closely with underlying fundamentals. This process of price discovery can be painful for investors, but it is ultimately necessary to ensure a more sustainable and rational market environment. New investors, in particular, should exercise caution and avoid the temptation to chase high-risk stocks in the hope of quick profits. A more prudent approach involves focusing on fundamentally sound companies with strong growth prospects and a proven track record of profitability. The stock market regulator, the Securities and Exchange Board of India (SEBI), along with stock exchanges and other intermediaries, should play a proactive role in increasing investor awareness and education. This includes providing investors with clear and unbiased information about the risks and rewards of investing in the stock market, as well as promoting the benefits of long-term investing and diversification. It would be detrimental to the long-term health of the Indian stock market if retail investors who entered the market after the Covid-19 pandemic were to become disillusioned by the current correction and withdraw their investments altogether. Therefore, it is crucial for regulators to avoid knee-jerk reactions, such as increasing trading margins, collateral requirements, or surveillance measures, which could further dampen market sentiment and discourage participation. Instead, the best course of action is to allow the correction to run its natural course, while providing investors with the necessary tools and information to make informed investment decisions.
The key is to emphasize that market corrections are a normal and healthy part of the investment cycle, presenting opportunities for long-term investors to acquire quality assets at more attractive valuations. By focusing on education and responsible regulation, the Indian stock market can emerge from this correction stronger and more resilient, attracting both domestic and international investors and fostering sustainable growth in the years to come. The ongoing situation in the Indian stock market highlights several crucial aspects of investing and economic cycles. It underscores the importance of understanding market corrections as a natural part of the investment landscape and emphasizes the need for investors to make informed decisions based on fundamental analysis rather than succumbing to speculative fervor. The surge in retail participation during and after the pandemic showcased the increasing accessibility of the stock market to a wider segment of the population. While this democratization of investment is a positive trend, it also underscores the need for robust investor education initiatives to ensure that new entrants understand the risks involved and are equipped to navigate market volatility. The fact that the Indian stock market outperformed many of its emerging market peers during the pandemic and its aftermath reflects the country's strong economic fundamentals and its attractiveness as an investment destination. However, the subsequent correction highlights the importance of maintaining a realistic perspective on valuations and avoiding excessive exuberance. The role of institutional investors, both domestic and foreign, is also critical to the stability and growth of the stock market. Their investment decisions can have a significant impact on market sentiment and price movements. The regulatory environment plays a crucial role in ensuring fair and transparent market practices, protecting investors' interests, and preventing excessive speculation. A well-regulated market is essential for fostering confidence and attracting long-term investments. Looking ahead, the Indian stock market is likely to continue to experience volatility in the near term as it adjusts to changing economic conditions and evolving investor sentiment. However, the long-term outlook remains positive, driven by India's strong economic growth potential, its large and growing consumer market, and its favorable demographic profile. To fully realize this potential, it is essential to foster a culture of responsible investing, promote financial literacy, and maintain a stable and predictable regulatory environment. By addressing these challenges and building on its strengths, India can solidify its position as a leading global investment destination.
Source: Editorial. Bourse correction