Sensex gains 8,000 points in 1 month, Nifty 50 tops 24,400; is Indian stock market overheated? A deep correction coming?

At first glance, it seems that the Indian stock market has entered a fresh bullish phase after the General Election outcome. The benchmark Sensex has surged over 8,000 points in just one month despite prevailing concerns over sticky inflation, elevated interest rates, and geopolitical tensions.

The 30-share pack Sensex hit a fresh record high of 80,392.64 on Thursday, July 4. This is 8,314 points higher than the index's June 4 close of 72,079.05. The Nifty 50 also hit its fresh peak of 24,401 on Thursday.

Year-to-date (till July 3 close), the Sensex has gained nearly 11per cent and the Nifty 50 has risen nearly 12 per cent. The mid and smallcap segments have outperformed as the Nifty Midcap 150 and Nifty Smallcap 250 indices have surged 23 per cent and 25 per cent, respectively.

Also Read: Nifty 50 is up 10% in the first half of the year; can it cross 26,000 by December?

This year's gains in the Indian stock market have been largely driven by solid economic growth, expectations of US Fed rate cuts, hopes for pro-growth government policies, and the prospects of a healthy monsoon. Healthy corporate profitability and political stability at the centre, too, underpin market sentiment.

Also Read: Expert view: Market outlook bright; positive on manufacturing, capital goods, exports, says Dikshit Mittal of LIC MF

Experts observe that the last 400-500 point rally in the Nifty 50 is healthy since it has been driven largely by fundamentally strong, high-quality large-cap stocks, including HDFC Bank, ICICI Bank, Axis Bank, Bajaj Finance, Reliance Industries and Bharti Airtel.

"The Indian stock markets have experienced a remarkable surge after the recent election results. This rally can be attributed to several positive factors, including increased participation from domestic institutional investors (DIIs) across different sectors in anticipation of strong upcoming reforms and favourable global market conditions," Osho Krishan, Senior Analyst - Technical and Derivatives, Angel One, told Mint.

Also Read: Sensex’s rapid rise: From 75,000 to 80,000 in just 58 sessions – a look at its journey so far

The market has been influenced by thematic shifts and sectoral rotations, leading to record highs in key indices.

Krishan underscored while this represents one of the most robust market runs in recent history, it's important to note that technical and derivative indicators suggest an excessively bullish sentiment, indicating a potential need for a period of correction.

"As the market reaps the low-hanging fruits, proactive risk management within the broader market becomes imperative," Krishan said.

Also Read: Sensex @80K | M&M, Tata Steel, among top 10 D-Street gainers, surge 15-75% in six months of 2024; full list here

Is the market overheated?

Many experts believe the market has discounted the majority of positives and lacks fresh triggers to sustain gains. Additionally, concerns have been growing over the current valuation.

According to Bloomberg, the Nifty 50's current price-to-earnings (PE) ratio, a key valuation metric, is slightly above 24 compared to its one-year forward PE of 19. The index's price-to-book (PB) ratio currently stands at 4 compared to its one-year forward PB of 3.2.

Valuations of mid and smallcap segments are at frothy levels, flashing warning signs.

"The Nifty 50 index may be reasonably valued in the context of historical valuations and bond yields, but most other parts of the market are trading at full-to-frothy valuations after a massive rerating in their multiples in the past two to three years," said brokerage firm Kotak Securities.

Apurva Sheth, the head of market perspectives and research at SAMCO Securities, underscored that India Inc.'s Q1 performance and the Union Budget, which will be presented in the last week of this month, will decide the future course of the market trajectory. This will also show whether the current rally is an irrational exuberance or whether the markets are overheated.

According to Sheth, on the technical front, markets have started to get a bit overheated.

"Sensex has moved up by 10 per cent in just 20 trading sessions. The index almost touches the 20-day upper Bollinger band, meaning this is a 2-standard deviation move. Such sharp moves are rarely seen in the markets. Thus, some consolidation or correction cannot be ruled out ahead of the Union Budget," said Sheth.

Is there a deep correction ahead?

A steep rise in the market has raised concerns that the Nifty 50 may be heading for a deep correction.

However, experts believe the market, especially the large-cap segment, will rise further from the current levels, and the chances of a deep correction in the benchmark index are less.

Experts observe that top banking stocks have been supporting the market benchmarks, and even after the recent run-up, the valuation of large banking stocks is fair in an otherwise overvalued market.

"In the near term, the bullish undercurrent of the market has the potential to outweigh the high valuations. The rally is now being led by the private large-cap banking stocks whose valuations are fair even after the recent run-up," said V K Vijayakumar, Chief Investment Strategist, Geojit Financial Services.

Nifty's valuation is high but it has not hit the unsustainable levels. On the other hand, the mid and smallcap segments appear to be at frothy levels. These segments may see some correction.

"The recent 1,000-point rally in the Nifty 50 and the Sensex crossing over 80,000 mark do not worry me. However, I have been for quite some time about the froth in the mid and smallcap segments, where earnings have been discounted more than 25 times," Vijayakumar told Mint.

Vijayakumar pointed out that there are signals of high valuation, but at the current juncture, there is no trigger on the horizon that can cause a sharp correction in the market of more than 10 per cent.

But the market will always be impacted by the unknown-unknowns, not the known-unknowns.

Sensex eyes new milestones

Vijayakumar believes the Sensex may reach the 1,00,000 mark, perhaps by the end of the year 2026, but it will depend on how the global scenario pans out, such as the extent of the Fed rate cut and the trajectory of US inflation.

"The US is in disinflationary territory, as indicated by May PCE (personal consumption expenditures) data, which was flat month-on-month and rose 2.6 per cent year-on-year. We can expect 4-5 rate cuts, with one or two rate cuts this year and 3-4 next year," Vijayakumar said.

Talking to CNBC-TV18, Raamdeo Agrawal, Chairman and Co-Founder of Motilal Oswal Financial Services, said the Sensex could hit 1,60,000 in the next five years by 2029.

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