Why India's stock markets could slide further on weak sentiment

Geopolitical tensions, a strong US dollar and unfavourable second-quarter results will continue to drag on equities, analysts warn

The BSE stock market building in Mumbai. The outlook for India's stock markets appears bearish in the short term, experts say. EPA

India's stock markets will continue to come under pressure as investor sentiment sours amid the Israel-Gaza war, elevated US Treasury yields and disappointing second-quarter company earnings, analysts say.

The benchmark S&P BSE Sensex has fallen 3.11 per cent over the past month to 63,782.80. The NSE Nifty 50, which represents India's 50-largest companies listed on the National Stock Exchange, is also down 3.01 per cent to 19,047.25 during the same period.

This is despite both indexes hitting record highs in September.

Although markets on Friday bounced back following six consecutive days of losses, some market analysts are not convinced the rebound can be sustained.

“Despite the strong rebound, we suspect the benchmarks are not out of the woods yet,” says Prashanth Tapse, senior vice president of research at Mehta Equities.

“For markets to remain buoyant, some resolution is needed between the ongoing war.”

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The outlook for India's stock markets appears bearish in the short term, says Suman Bannerjee, chief investment officer at hedge fund Hedonova.

“The combination of geopolitical tensions, a strong US dollar and unfavourable second-quarter results suggests that there is a high likelihood of further decline over the next three to four months,” Mr Bannerjee says.

However, global stock markets are experiencing similar falls, including in the US, the UK and Japan, as the Israel-Gaza war continues to rattle investors.

The conflict can potentially cause supply-chain disruptions and push world inflation higher, says Amar Ambani, group president and head of institutional equities at YES Securities India.

“That would mean central bankers holding on to high rates for longer than expected,” Mr Ambani says.

“This was bound to impact markets, which can ill-afford another war when economies are already battling high inflation and interest rates, an ongoing Russia-Ukraine war and a slowing China. The margin of safety on the valuation front is low in the near to medium term for Indian equities.”

Soaring US Treasury yields have also added to the appeal of bonds over equities, says VLA Ambala, a research analyst and co-founder of research platform Stock Market.

The yield on benchmark 10-year US Treasuries rose to 5 per cent last week – the highest level since 2007 – driven by global economic concerns and expectations that the US Federal Reserve will raise interest rates at its next meeting that begins on Tuesday.

“There are concerns that the [US] government's persistent borrowing could push the bond yields even higher,” says Ms Ambala.

“This might prompt foreign investors to sell their holdings in emerging sectors in India and flock back to dollar assets to generate high yields.”

But after India's stock markets surged to all-time highs last month, it also means they are poised for a correction, says Swapnil Shah, director of research at broker StoxBox.

“Markets looked overstretched, especially the mid-and small-cap space, where valuations seemed to have run ahead of their earnings visibility,” says Mr Shah.

“We believe that a triple whammy of expensive valuation, firm US bond yields and geopolitical tensions in the Middle East has played on the market sentiment.”

Rising US bond yields triggered an exodus of capital from emerging economies, including India, as dollar returns became more favourable, Mr Shah says.

The heightened geopolitical tensions due to the Israel-Gaza conflict have also led to a rise in oil prices, which is negative for an oil-importing country like India, he adds.

Meanwhile, investors are also apprehensive about the falling Indian rupee and outflow of foreign investments, says Prateek Toshniwal, an angel investor and financial adviser.

The rupee has weakened to 83.41 against the strengthening US dollar, while the outflow of foreign funds has added to pressure on banking and IT stocks, in particular, Mr Toshniwal said.

Foreign investors have withdrawn $3.6 billion from India's stock markets since the beginning of September after injecting a net $21.3 billion over the previous six months, according to Bloomberg.

Second-quarter earnings are also worrying investors, with large IT companies, including Infosys and Tata Consultancy Services, warning of weakening demand in the sector and the negative impact it will have on revenue.

The country's IT sector is leading the decline in stock markets. Infosys's share price has fallen 3.79 per cent to 1,381.05 rupees over the past month on the BSE Sensex.

External factors will play a significant role in how Indian equities perform in the near term and the US Fed's monetary policy meeting will be closely watched, Mr Shah says.

“Any expected recovery in markets from hereon would be driven by a softening of US bond yields,” he adds.

“We would closely monitor the US Fed chairman's comments post the meeting scheduled [on Tuesday and Wednesday] to decipher the interest rate environment in the US going forward.”

If the negative sentiment persists, there is a risk that it will impact the appetite for initial public offerings, says Amit Goel, chief global strategist at asset management company Pace360.

“We do expect the IPO momentum to wane over the next few months as the sentiment in the retail segment of the market has particularly turned unfavourable … issuers may expect a lesser participation in their issues leading to postponement or cancellation of some of the planned IPOs,” says Mr Goel.

However, Mr Ambani of YES Securities is not yet concerned about delayed IPOs.

“IPO plans may continue smoothly this year, even if the Nifty was to correct another 800 points from here,” he says.

“Only if the correction is much larger, I would imagine that many companies will need to defer their listing plans to 2024.”

Although markets are clearly under pressure, he remains upbeat on the longer-term outlook for Indian equities.

“Near-term corrections apart, there is significant comfort from a medium to long-term perspective,” says Mr Ambani.

“Structurally, we are positive on Indian equities. I see the present downtrend as a correction in the long-term uptrend. It is tough to state the level at which the market will stabilise, but it's not odd to see even a 10 to 20 per cent correction in bull markets,” he adds.

“In my view, timewise, this downwards phase should not last for more than two to three months.”

With a general election due to be held in India next year, this could also help markets stage a recovery in the coming months.

On Thursday, JP Morgan upgraded Indian stocks to overweight based on its expectation that the government will spend more ahead of the vote to improve public opinion, which would help to drive consumption and market sentiment.

This is in contrast to research published by Goldman Sachs earlier this month, which warned that global economic headwinds and high valuations mean investors should remain cautious about Indian equities ahead of the polls.

However, Alok Agarwal, portfolio manager at Alchemy Capital Management, believes that India is a "rare large market” that offers double-digit growth in nominal gross domestic product and corporate earnings.

At the same time, the government's finances are relatively strong.

“This confluence of factors is likely to ensure the outperformance of India continues and would possibly limit downsides [of equities],” says Mr Agarwal.