Indian stock market: Nifty 50 down almost 2% from its all-time high; 5 factors that indicate it could correct up to 10%

Indian stock market witnessed a significant selloff during the morning session of trade on Thursday, July 25, as the benchmark indices, the Sensex and the Nifty 50, fell almost a per cent each. Both frontline indices have been falling for the last five consecutive sessions. The Nifty 50 is now down about 2 per cent from its all-time high of 24,854.80, which it hit on July 19.

Weak global cues and the budgetary proposals of an increase in taxes on long-term and short-term capital gains (LTCG and STCG) appear to be the immediate negative triggers for the market.

While global uncertainty could persist for a longer period, the concerns over the capital gains taxes are expected to ease soon.

However, there are significant concerns that could lead to a deeper correction in the market.

Here are five crucial factors that can cause a correction of up to 10 per cent, or even beyond that, in the Indian market:

1. Overheated market

There are valuation concerns across market segments. While the valuation of mid and small-cap segments could be at frothy levels, the large caps, too, are trading at a premium.

Key valuation matrices of Nifty 50 are in the red. As per Bloomberg data, the current price-to-earnings (PE) ratio of Nifty 50, at 24.5, is above its one-year forward PE of 19.2. The price-to-book (PB) value of Nifty 50 is at 4, which is above its one-year forward PB of 3.2.

"There are valuation challenges across caps. Valuations are higher also because, after a long time, there is comfort in terms of the durability of the growth rate," Pankaj Pandey, the head of research at ICICI Securities, told Mint.

2. Unimpressive Q1 numbers

Indian corporate earnings for the April-June quarter (Q1FY25) have been mixed so far and have failed to boost market sentiment.

Experts point out that the market rally so far has been supported by strong corporate earnings, which appear to be slowing down. This could fail to sustain the market's current gains.

"The rally in the Indian stock market has been supported by earnings growth. According to the latest Economic Survey, corporate earnings grew by 30 per cent in FY24, and Nifty's earnings rose by 24 per cent. The Q1 earnings so far have indicated a slowing down in corporate earnings," said V K Vijayakumar, Chief Investment Strategist, Geojit Financial Services.

"There are signs of deceleration in corporate earnings after the impressive 24 per cent growth in Nifty earnings in FY24. The excessive valuations in certain segments in the broader market are unlikely to be sustained despite the irrational exuberance of retail investors," Vijayakumar said.

3. The lack of fresh positive triggers

The market seems to have discounted most triggers. With elections and the Budget over, the market is struggling to find a fresh trigger to sustain and extend gains. Experts say the lack of fresh triggers may increase stock and sector-specific actions in the market, and there may be bouts of profit bookings at higher levels.

4. Uncertainty over interest rate cuts

Uncertainty over the US interest rate cuts is still present, which could weigh on market sentiment. Fed Chair Jerome Powell has indicated that the US central bank will remain data-dependent when deciding on policy rates.

According to the latest Reuters poll of economists, the US Fed may cut rates twice this year—first in September and then in December. While easing inflation can nudge the Fed to consider cutting rates, resilient US consumer demand is also a factor that the central bank has to consider.

5. US Presidential Election

The upcoming US Presidential Election is a key factor that can impact market sentiment globally.

Uncertainty over the outcome of the US presidential election can keep markets volatile in the near term. Even the actual outcome can upset the market if the former President of the United States, Donald Trump, comes back to power.

Trump has already hinted that he may not hesitate in imposing fresh tariffs and increasing existing tariffs on imports. This could hit the global economy and markets.

"Uncertainty surrounding the US presidential election will start impacting the market. I believe this is the biggest negative trigger for economies and markets worldwide. Donald Trump's presidency is increasingly appearing as a possibility now. He has the potential to trigger a global trade war, which will impact global economies and markets," said Vijayakumar.

Time to be worried?

Experts say it is early to say that the market may correct significantly from the current levels.

"It is early to conclude that a correction phase has started in the Nifty 50 because dips have consistently been buying opportunities in this rally, which started in April 2020. We saw many dips like this before, and all that turned out to be buying opportunities," said Vijayakumar.

Vijayakumar pointed out that there is froth in the broader market, which has been supported by fund flows in mid- and small-caps and the irrational exuberance of retail investors.

"It is desirable to have a correction because it will make the market healthy. We have not seen a 5 per cent correction recently. The real trigger for corrections comes from unknown factors. The unknown-unknowns, the black swan events, which could come in any form, including fresh geopolitical tensions," said Vijayakumar.

Pandey observed that 5-10 per cent corrections are the norm and can happen multiple times in a year.

"We do not see anything extraordinary in terms of correction that we have been witnessing of late. Domestically, we do not find many negative triggers that can cause a correction of over 10 per cent. However, there is uncertainty on the global front," said Pandey.

"We have US elections coming up; the US market is volatile. So, global factors-led volatility is possible, but domestic triggers-led volatility may be digested. If the market corrects beyond 5 per cent, there may be a fresh spell of buying, as the structural positives remain intact," Pandey said.

Amol Athawale, VP of Technical Research at Kotak Securities, pointed out that this week, the Nifty 50 has consistently faced selling pressure at higher levels. On intraday charts, the index is holding a lower top formation, which suggests weak sentiment and is likely to continue in the near future.

"However, the medium-term technical setup is still on the positive side. For short-term traders now, the 20-day SMA (simple moving average) or 24,300 would act as a trend decider level. As long as the index trades below this level, the weak sentiment will likely continue. Below this level, the market could retest the level of 24,150-24,100," said Athawale.

"Positional traders can take long bets between 24,200 and 24,100 levels, with 24,000 support stop loss. Conversely, if it succeeds in trading above 24,300, it could bounce back to 24,500. Further upside may also continue, which could lift the market to 24,650. A close below 24,000 could lead to further weakness to 23,500 levels," Athawale said.

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