6-day Sensex crash takes Indian stock market to mid-August lows; further decline likely ahead?

Indian stocks continued to face intense selling pressure on Monday, marking the sixth consecutive trading session of decline, underscoring the raising concerns in the market as investors weigh the impact of global geopolitical tensions, particularly ongoing tensions between Iran and Israel, alongside the steady selling from the foreign institutional investors. 

The Nifty 50 and Sensex both ended today's session in the red, each dropping over 0.80%, pushing them to their lowest levels since mid-August. From their recent peaks, the Nifty 50 has corrected nearly 7%, while the Sensex has fallen close to 6%. 

Additionally, investors have likely taken advantage of the recent market correction to book profits, further intensifying the downward pressure on market indices. Both indices posted their worst weekly performance in two years last week.

The month gone by was dominated by global policy developments, with the US Fed embarking on the much-anticipated easing path with a 50-bps cut in the Fed Funds rate, followed by the slew of policy measures announced by China in a bid to revive its economy and capital markets, which in turn encouraged investors to show greater interest in riskier assets.

However, October has brought new challenges for investors, redirecting their attention to the escalating conflicts in the Middle East, increasing crude oil prices, and their potential impact on global trade. Analysts are becoming more apprehensive that these developments could influence the rate cuts of major central banks in the upcoming policy meetings.

Amid these developments, investors are likely to adjust their strategies by retreating from stocks to mitigate volatility in their portfolios. This cautious approach is evident in the recent underperformance of major global equities, with the Indian stock market particularly affected the most.

Concerns also linger over the possibility that an intensifying conflict between Israel and Iran could escalate into a full-scale regional crisis. Recent reports suggest that Israel is planning an attack on Iran, targeting its oil and nuclear facilities in response to last week's missile attack by Tehran.

As Iran remains a major oil-producing nation, any attacks by Israel against Iran's oil facilities could potentially drive the crude oil prices to elevated levels, which were already reacted sharply to the recent tensions.

Iran is a member of the Organization of the Petroleum Exporting Countries (OPEC) with production of around 3.2 million barrels per day (bpd), or 3% of global output. Iranian oil exports have climbed this year to near multi-year highs of 1.7 million bpd despite U.S. sanctions.

Rising crude oil prices can have significant repercussions across various sectors in India, including aviation, automotive, paints, tyres, cement, chemicals, synthetic textiles, and flexible packaging.

The recent surge in oil prices has already led to a negative reaction in the stock performance of companies within these industries, as higher oil costs can substantially impact operating expenses.

The rise in crude prices will also pose challenges for a country like India, which is significantly dependent on oil imports. Furthermore, the ongoing instability in the Middle East not only increases the likelihood of higher energy prices but also poses a threat to global supply chains. This, combined with the rising U.S. Dollar Index, is putting more pressure on Indian stocks.

FPIs: On ‘buy China, exit India’ mode

Foreign portfolio investors (FPIs) made a notable U-turn in October, withdrawing ₹30,719 crore from Indian equities within the first 3 days, according to data from the Trendlyne. 

The most significant sell-off occurred on October 4, when FPIs offloaded equities worth ₹15,506 crore, signaling a sharp decline in investor confidence. Experts suggest that FPIs are redirecting their investments toward China and Hong Kong following the announcement of substantial policy measures by Beijing aimed at revitalizing its faltering economy and capital markets.

This shift has been fueled by renewed optimism surrounding a potential recovery in the Chinese economy and improved earnings of Chinese companies in response to these stimulus measures. Additionally, the more attractive valuations of Chinese stocks compared to the elevated valuations of Indian stocks have also contributed to the growing interest from FPIs.

Consequently, the Shanghai Composite Index has surged by 17.4% over the past month, while the Hang Seng Index has soared over 32% during the same period.

Is more correction likely?

The initial turmoil in the stock market triggered by the Russia-Ukraine and Israel-Hamas conflicts was brief, as both situations have persisted for several months without leading to significant long-term disruptions. A similar dynamic is currently unfolding with the rising tensions involving Israel, Hezbollah, and Iran, which are also anticipated to continue. 

However, unless these conflicts escalate significantly, the existing market anxiety is likely to be temporary.

Historically, the Indian market has shown the capacity to recover from geopolitical tensions, particularly when they do not result in major escalations. Investors often adapt their strategies during such periods, focusing on the underlying economic fundamentals rather than short-lived geopolitical concerns.

Meanwhile, every dip in the Indian stock market recently caused by Foreign Portfolio Investor (FPI) outflows has been promptly bought up by domestic institutional investors (DIIs), with strong support from retail inflows.

Whenever global uncertainties and market volatility have led to sell-offs by FPIs, domestic investors have stepped in to stabilise and drive the markets higher. This consistent pattern of domestic buying has been bolstered by robust retail investment, ensuring that even amid global economic turbulence, the Indian stock market remains resilient.

"FII selling is likely to be absorbed by DII buying, and, therefore, it is unlikely to do serious long-term damage to the market. Since a significant part of FII holdings is in banking stocks, this segment may continue to face downward pressure. This will provide opportunities for long-term investors to buy the frontline banking stocks. This segment is attractively valued, and the sector is doing well," said Dr V K Vijayakumar, Chief Investment Strategist, at Geojit Financial Services.

DIIs are increasingly emerging as formidable players in the market, boasting deeper financial resources compared to their foreign counterparts, he added.

While the steady inflows have resulted in stretched valuations, analysts believe this trend is likely to continue in the near term. As retail investors keep pouring money into the market, mutual funds are compelled to invest incoming funds, irrespective of valuation concerns or their level of conviction, which helps to reduce market sensitivity to global tensions.

Disclaimer: The views and recommendations given in this article are those of individual analysts. These do not represent the views of Mint. We advise investors to check with certified experts before making any investment decisions.