As on 20th February 2025, Nifty has corrected by 12.5 percent from the September 2024 peak. Around 10 percent corrections are par for the course for stock markets. In India, this has happened on 22 occasions in the last 25 years. But the newbies who flocked into the market during the boom phase following the Covid crash are a perplexed lot. Because, about 75 percent of the 10.7 crore unique investors in India haven’t seen or experienced a sharp market correction. More importantly, the newbies have portfolios heavily skewed towards small and midcaps where the crashes have been severe. Many small and midcaps have corrected by more than 30, 40, and even 50 percent. Through Geojit Insights, we have been warning investors about the excessive valuations in mid and small caps.
Now all investors are asking the same questions:
When will the market correction end?
Why is the market not responding to a good Budget and rate cut by the RBI?
When will the FIIs come back?
Let’s get the issue in perspective.
Post Covid, the Indian economy staged a ‘V’ shaped growth recovery with GDP growing by 9.1 percent, 7 percent, and 8.2 percent in FY22, FY23, and FY24 respectively. This sharp turnaround in growth was accompanied by an impressive turnaround in corporate profits: corporate profits compounded at 21 percent during FY20 to FY24. The market responded to these favorable fundamentals and the Nifty delivered an impressive 25 percent CAGR during the period June 2020 to September 2024. The outperformance of the broader market triggered huge capital inflows into the mid and smallcaps, which pushed their valuations into unsustainably high levels. The median mid and smallcap PE multiples crossed 40, indicating bubble valuations. The newbies, driven by recency bias, continued to pour money into the overvalued mid and smallcaps. Some mutual funds flagged the risk by stopping fresh bulk investments into small caps. But the party continued.
The euphoria started diminishing when the Q2 FY25 GDP numbers dropped sharply to 5.4 percent. The growth recovery, which was driven by public capex, couldn’t be sustained in the absence of strong recovery in consumption. Worse was to follow; corporate earnings dropped sharply. FY25 is likely to end with a mediocre earnings growth of around 7 percent.
The market appears to be bottoming out. However, a rally will need support from external and internal triggers. Externally, the dollar index and the US bond yields need to decline from their current high levels. This is likely, but the timing would be difficult to predict. Trump tariffs will raise the inflation levels in the US, inviting hawkish comments from the Fed, which, in turn, can bring the dollar and the US bond yields down. More important than this potential external tailwind is the recovery in India’s GDP growth and corporate earnings. The fiscal stimulus provided in the Budget 2025 is expected to boost consumption, paving the way for a GDP growth rate of 6.8 to 7 percent in FY26. If, simultaneously, corporate earnings too improves in FY26 to, say, 15 percent, that can trigger a mild rally in the market.
The market correction has made the valuations of large caps fair, and in some segments like financials attractive. Long-term investors with an investment time horizon of more than three years can utilize this opportunity to make bulk investment in large cap, aggressive hybrid and balanced advantage mutual funds. Systematic transfer plans for the next six months to one year also can be considered.
