The result of the Lok Sabha 2024 election rattled investors’ cages, but the Indian financial markets bounced back quickly from that low point on June 4. Data indicates that since then, the Nifty 50 and the S&P BSE Sensex have rebounded by roughly 2,400 points and 7,500 points, respectively, or 11% and 11% of the total, respectively.
The huge surge from the lowest points has prompted apprehension among analysts, particularly those at Kotak Institutional Equities, who perceive ‘possible dangers’ in the markets at now, but not ‘imminent risks’.
They claimed that irrational enthusiasm among non-institutional (and some institutional) investors is a major factor driving the current market sentiment. They feel that the frothy values in certain sectors and the high valuations across sectors generally are mostly reflective of the extraordinary bullishness among institutional and even non-institutional investors.
Nevertheless, major market corrections generally result from four factors, according to Sanjeev Prasad, co-head of Kotak Institutional Equities (KIE), who co-wrote a recent note with Anindya Bhowmik and Sunita Baldawa: a) macroeconomic difficulties; b) leverage problems with banks, businesses, governments, and households; c) political or social instability; recurrent bouts in many EMs; and d) natural or man-made disasters like pandemics, war, etc.
Market outcomes
“The market has reached epic levels of faith, and it might take something equally big to shatter that faith. For non-institutional investors, high or even bubble prices are meaningless, they claimed.
According to Kotak Institutional Equities, there are four major risk concerns or troubling elements that can cause a correction in the interim.
Government priorities: According to the KIE paper, any significant shift in the government’s priorities or policies may result in a market correction. Any change in the way the government taxes stocks, particularly a greater capital gains tax, could pose some risk to the market.
“Investment-related sectors may be at maximum risk from any change in government priorities, especially given their extremely high multiples. For now, we expect the central government to broadly continue with its economic agenda of the past 6-7 years,” the note said.
The possibility that the government will focus more on populist measures to boost consumption may increase as a result of the BJP’s underwhelming performance in the most recent Lok Sabha polls, particularly in some states where voting is imminent, and any further setbacks in upcoming state elections, especially in Haryana and Maharashtra, Prasad wrote.
Increased regulation: According to Prasad, the capital markets regulator Sebi may wish to maintain a more “orderly” market but is unsure of how to go about it. In March 2024, Sebi had pointed out the foam that was forming in the mid- and small-cap sectors. According to KIE, the valuations have since increased, particularly in a number of low-quality and low-liquidity firms.
“We expect the regulator to continue to monitor the risks arising from a sharp increase in stock price in low-float stocks and a sharp rise in retail activity in options market,” the KIE note said.
PSU stocks at unaffordable valuations: According to the letter, PSU stocks are far too expensive. According to Prasad, any significant divestiture from PSUs could expose their true worth, particularly if they are trading at unaffordable levels. Even though the government has been falling short of its divestiture target for a number of years, KIE thinks it might wish to capitalise on the excitement around PSU equities and expand share sales by using a combination of OFS and ETFs.
Corporate earnings fall short of expectations: according to the paper, the present multiples of the majority of investment and consumption companies factor in rapid growth in sales and volume as well as high margins and profitability over the long run. They think that any setback on this issue poses a risk to the markets.
“We are reasonably sanguine about our revenue and volume growth assumptions but it is possible that margins may disappoint. However, it may take a number of quarters of consistent disappointment for investors to question the extant narratives, given the strong conviction of the market participants about robust earnings and growth prospects,” the note said.