Elevated valuations and optimistic market sentiments in the United States (US) have raised the likelihood of a 'meaningful market correction' in 2025 in the Indian stock markets, said the Economic Survey 2025 tabled in the Parliament on Friday.
Should such a correction occur, the Economic Survey 2025 cautioned, it could have a cascading effect on India, especially given the increased participation of young, relatively new retail investors in the Indian stock markets.
"Many of these investors that have entered the market post-pandemic have never witnessed a significant and prolonged market correction. Hence, if one were to occur, its impact on sentiment and spending may be non-trivial," the Economic Survey 2025 said.
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Nifty 50 - S&P 500 correlation
The Indian equity market, according to the survey, has been notably sensitive to movements in the US market. The Nifty 50 index, it said, has historically shown a strong correlation with the S&P 500.
An analysis of daily index returns between 2000 to 2024 reveals 22 instances when the S&P 500 corrected by over 10 per cent, the Nifty 50 posted a negative return in all but one case, averaging a 10.7 per cent decline.
On the other hand, during 51 instances when the Nifty 50 experienced a correction of over 10 per cent, the S&P 500 exhibited positive returns in 13 instances, with an average return of -5.5 per cent.
“Even as the resilience demonstrated by the Indian market, supported by growing retail participation, is promising, the risks associated with a potential US market correction cannot be overlooked, given historical trends,” the Economic Survey 2025 said.
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US markets on a roll
The US stock markets, meanwhile, the Economic Survey 2025 said, has had a 'solid run' for the second year in a row, outperforming the broader developed market pack on the back of healthy corporate earnings and economic resilience, strengthening rate cut expectations early in the year and an all-time high investor confidence.
The rally over the last two years in the US stock markets, the survey notes, has been largely driven by a few mega-capitalisation technology companies — Apple, Microsoft, Amazon, Alphabet, and Nvidia. This, it said, is reflected in a strong over 40 per cent year-to-date (YTD) return in the S&P 500 Top 10 Index.
Following a 24 per cent gain in 2023, the S&P 500 Index is well on course to generate a over 20 per cent return in 2024. From a longer view, the index has rallied 56 per cent in 2023 and 2024, more than double that generated by the equal weight index.
This, along with tapering rate cut expectations, with the US Federal Reserve’s dot plot now suggesting a 50 basis points (bps) cut in 2025, down from the earlier guidance of 100 bps, has added to the potential risks and uncertainties as regards the sustainability of the US markets, the Economic Survey 2025 said.
On Wednesday, the Federal Open Market Committee (FOMC) kept rates on hold at their January meeting, as widely expected. The meeting statement was hawkish, but Jerome Powell, US Fed chair, downplayed the hopes of a rate cut in March 2025.
"We have revised our Fed call and now expect rates will remain on hold through the year," wrote analysts at Nomura in a recent note.
Meanwhile, the rally in the US stock market has pushed valuations to an unattractive zone, currently at their third highest levels as indicated by Shiller’s S&P 500 Cyclically Adjusted Price-Earnings Ratio, or the CAPE ratio, warrants some caution, the survey said.