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The Indian stock markets have recovered sharply from the June 4 low when the outcome of the Lok Sabha 2024 election spooked sentiment. The S&P BSE Sensex and the Nifty 50 have recovered nearly 7,500 points (11 per cent) and 2,400 points (11 per cent), respectively since then, shows data.
The sharp recovery from the lows has made analysts cautions, especially at Kotak Institutional Equities, who see 'potential risks' in the markets at the current levels, but not 'imminent risks'.
The current market sentiment, they said, is largely driven by irrational exuberance among non-institutional (and certain institutional) investors. The high valuations across sectors in general and frothy valuations in specific sectors, they believe, largely reflect the extremely bullish sentiment among non-institutional investors and even among certain institutional investors.
That said, big market corrections, wrote Sanjeev Prasad, co-head at Kotak Institutional Equities (KIE), in a recent note co-authored with Anindya Bhowmik and Sunita Baldawa, typically stem from four areas — a) macroeconomic challenges; b) leverage issues with banks, companies, government, households; c) political or social instability; recurring bouts in many EMs; and d) natural or man-made disasters such as pandemic, war, etc.
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“The faith in the market is at epic levels and may require something equally epic to break the faith. High or even bubble valuations are irrelevant for non-institutional investors,” they said.
Meanwhile, here are four key worrying factors / risk sources that can trigger a correction, according to the Kotak Institutional Equities.
Government policies: Any major change in government policies or priorities can trigger a market correction, the KIE note said. The market could be at some risk from any change in government taxation policies on equities, specifically higher capital gains tax on equities.
"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.
BJP's weaker-than-expected performance in recent Lok Sabha polls, especially in certain poll-bound states and any further setbacks in forthcoming state elections, particularly Haryana and Maharashtra, may increase the possibility of the government focusing more on populist measures to revive consumption, Prasad wrote.
Higher regulations: The capital markets’ regulator Sebi, Prasad believes, may want to ensure a more ‘orderly’ market, but is unsure how it can do so. Sebi had highlighted the froth building up in the mid-and small-cap segments in March 2024, and KIE believes the valuations have become higher since then, especially in several low-quality and low-liquidity stocks.
"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 unfathomable valuations: PSU stocks, the note said, are extremely overvalued. Any large divestment in PSUs, especially those trading at unfathomable valuations, Prasad wrote, may reveal their true value. Though the government has missed its divestment target since the past several years, KIE believes it may want to take advantage of the euphoria surrounding PSU stocks and increase stake sale, through a mix of OFS and ETFs.
Corporate earnings disappoint: The current multiples of most consumption and investment stocks, the note said, bakes in strong growth in revenues/volumes and elevated margins/profitability for an extended period of time. Any disappointment on this front, they believe, is a risk for 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.
