Why did the market lurch lower after a 52-week high? What should small investors do?

Equity barometer Sensex fell about a percent on November 21, extending losses into the third consecutive session.

On November 16, the Sensex hit its 52-week high of 62,052.57 but failed to hold altitude and has been in the red since then. However, a fresh wave of profit booking after the 52-week high should not surprise investors. Amid concerns about rigid inflation, rate hikes and recession, the market is expected to remain in a range, say experts.

The market is not out of woods yet. The biggest risk that it still has to deal with is the rate hike and the subsequent recession. As global financial firm Goldman Sachs said that the global equity bear market is not over.

"We continue to think that the near-term path for equity markets is likely to be volatile and down before reaching a final trough in 2023," Reuters quoted Goldman Sachs saying so.

The India Story

The Indian market has shown remarkable resilience in the last couple of months as investors anticipated healthy economic recovery and peaking inflation and rate hikes. Foreign portfolio investors (FPIs) resumed buying Indian stocks and the sense of "the worst is behind" started to prevail.

However, the market perhaps ignored the fact that inflation is still above the tolerance band of major central banks, rate hikes will continue, a recession is almost certain, and the valuation of the Indian market was at a premium.

The market may hope economic recovery and signs of inflation peaking will help it but several short and medium-term issues may puncture its optimism.

"We see several issues (both short-term and medium-term) that may deflate the market’s expectations. The short-term issues include (1) weaker-than-expected growth and (2) higher-than-assumed interest rates, which could limit earnings surprises," brokerage firm Kotak Institutional Equities said in a note.

"The medium-term issues comprise (1) weak macroeconomic conditions (high fiscal and current account deficits) and (2) incomplete reforms in the medium term, which may pose challenges to India’s medium-term growth prospects. India’s high current account and fiscal deficits matter less at low global and domestic interest rates. They will matter more now given the high cost of financing such large deficits," Kotak said.

Kotak highlighted that even economic recovery is not as robust as is generally believed.

"A deeper look into India’s economic recovery would suggest that India’s economic growth is not as robust as is generally perceived. Q1FY23 GDP data was quite disappointing when viewed on a three-year CAGR basis with private consumption growing at 3.2% CAGR only in Q1FY20-Q1FY23," said Kotak.

Kotak also sees a limited scope of earnings upgrades given the backdrop of (1) weaker-than-expected domestic economic recovery, (2) slowdown or recession in developed market countries and (3) higher-than-expected interest rates, which may affect demand.

"Our net profit estimates for FY2023 and FY2024 saw modest cuts in the Q2FY23 results season with downgrades in automobiles and metals and mining sectors. We also see downside risks to earnings of export-oriented sectors such as IT services," said Kotak.

Apart from all this, the rich valuation of the market has emerged as a fresh concern.

"Valuations of the Indian market are quite rich. We find little value across sectors. Valuations of non-financial ‘growth’ stocks, whether large-cap or mid-cap, are extremely rich and many are trading at higher than March 2019 levels when bond yields were at a similar level. India’s macroeconomic position has weakened considerably since then," Kotak observed.

"Valuations of the financials stocks look to be reasonable although valuations are starting to look fair after the recent strong rally in banking stocks. Valuations of ‘value’ stocks look to be inexpensive but are fair in the context of their business models," said Kotak.

What should you do?

Avoid excessive bets in this market when the macro indicators are giving mixed signals and uncertainty continues to prevail.

Vinod Nair, Head of Research at Geojit Financial Services is of the view that in the absence of major domestic triggers, the domestic market may continue its focus on global trends.

"Considering the current market scenario, a balanced approach with a mix of equity and debt, 60:40 for an average risk-averse investor, is advised as interest yields are becoming attractive, and the economy is slowing," said Nair.

"This is the time to play defensively rather than taking risky shots at the goal. Cautious defensive games can be a good short-term strategy," said V K Vijayakumar, Chief Investment Strategist at Geojit Financial Services.

Buy quality stocks for a long-term perspective. Many analysts believe the intermittent corrections in the market are good opportunities to accumulate quality stocks.

"I will be cautious in the near term since we are trading at high valuations. At these levels, the valuations look expensive. From a medium-term perspective, since inflation, the biggest issue plaguing the global economies has been moderating, the outlook is positive. It's a good time to be invested in Indian equities,” said Sumit Chanda, CEO and Founder of JARVIS Invest.

Disclaimer: The views and recommendations given in this article are those of individual analysts and broking firms. These do not represent the views of MintGenie.