Short-term stock market correction cannot be ruled out, expect high volatility due to inflation concerns

By Narendra Solanki

Markets will continue to witness volatility so far in 2022 with a period of recovery in between, as inflation continues to climb and central banks in most countries hastily tighten monetary policy to avoid falling behind. Most of the rise in global inflation has been driven by supply-side factors such as supply disruptions in China due to the zero-Covid policy, insufficient supply of critical materials such as microchips, and bottlenecks due to Russia-Ukraine war accelerating global inflation led to commodities for both industrial and consumer goods. Most of these factors have shown some signs of improvement recently and inflation numbers are likely to decline in the coming quarters.

Meanwhile, global growth has begun to decline. Slowing policy adjustment, the end of pent-up demand, rising commodity prices, rising interest rates and lowering corporate, consumer and investor optimism are key factors. The combined effect of high inflation, rapid monetary tightening and slowing growth rates is negative for financial markets in the near term and markets are already buzzing with fears of a recession if growth slows significantly without any favorable improvement in inflation. That was already seen as major indices that recently corrected by about 15-17%.

Since the year 2000, Indian stocks have been one of the best performers worldwide for most time horizons from one to twenty years. A strong economy, better business performance, increasing investment in the Indian stock market from both foreign and domestic sources, and a large number of companies to choose from in the Indian market are factors that have led to the superior performance of Indian stocks. However, concerns about the Indian stock market remain high valuation multiples, especially when compared to global peers.

In addition, the combination of improved corporate earnings growth and recent market corrections has lowered valuation multiples for Indian stock indices. The price-to-earnings ratio for Nifty 50 or Sensex is currently much lower than the 2016-21 averages and broadly similar to the 2011-15 averages. As a result, even valuation concerns for Indian equity markets are largely misplaced when looking at long-term growth for the Indian corporate sector.

Also, despite better long-term prospects, opportunities for short-term market correction cannot be ruled out. We live in an interconnected world where the foreign institutional investors are the largest financial investors in the Indian stock market. India cannot remain unscathed if the global stock market continues to correct. In addition, financial markets generally react during both the rally and correction phases. In view of this, it is reasonable to expect high volatility in the stock market for the foreseeable future, as controlling inflation remains a top priority for global central banks.

(Narendra Solanki – Head- Equity Research (Fundamental), Anand Rathi Shares & Stock Brokers. Opinions expressed are those of the author.)

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