The probability of the much-awaited rate cut event is scheduled to approach on 18 September. Investors from all over the world eagerly await to witness the dovish stance that the US Federal Bank would embrace in the upcoming monetary policy.
Usually, the interest rate cuts are considered in favour of the equity market. However, the ease in monetary policy is often a sign of weak economic performance.
A recent report by Nuvama Wealth Management highlighted that currently several indicators from the US labour market are flashing warning signs, suggesting economic challenges ahead. This scenario is notably different from 2007 when domestic demand was robust and contributed to the initial market surge. Now, however, domestic demand is weaker, raising concerns about the strength of economic recovery.
Furthermore, compared to 2019, market valuations are considerably more stretched, with equity prices appearing high relative to earnings potential.
Rate Cuts To Pitfall
“The combination of overvaluations and recession fears does make the Indian market vulnerable to sharp corrections, but this is more pronounced in the small- and mid-cap space. That is because the valuations have stretched in those segments. However, large-cap stocks appeared resilient on stronger structural fundamentals with better earnings visibility,” Ravi Singh, Senior Vice President, Retail Research, Religare Broking.
While economic theory often points to such cuts providing a boost to equity valuations in India, the historical data presents a more nuanced picture. As per the report in 2001, after the Fed initiated rate cuts, India's Nifty index saw a significant decline of 35 per cent. In 2007, the market plummeted by 60 per cent amid the global financial crisis. More recently, in 2019, despite Fed easing, the markets remained largely flat.
Investors get scared of an impending recession and pull themselves back from so-called riskier assets, which places Indian markets in that bracket, too. Global liquidity pulls toward safer bets and puts pressure on emerging markets. But in India, the current momentum on the economic front remained robust and well supported by strong growth, along with increasing private sector capital expenditure, said Singh.
Singh further stated that while there is a likely downside correction in the Nifty, it may not be as lengthy or intense as it was in 2008. The strong growth trajectory of India should cushion this effect, and such correction shall be short-lived.
Foreign Investors' Mood
Foreign institutional investors (FIIs) account for a significant part of the Indian equity market. They account for a staggering 18 per cent stake in the market, while they have purchased around Rs 16,600 crore in September, they still remained net sellers in the year 2024 so far.
Foreign Portfolio Investors (FPIs) on the other hand whose investments are valued at around Rs 69 trillion in the Indian market, continued their bullish stance on Indian stocks, infusing Rs 27,861 crore in September, according to data from the National Securities Depository (NSDL).
“There is a good possibility of FIIs selling, and we are expecting to see an influx of funds into US equities. However, this won’t hamper the liquidity of Indian equities. Most of the inflows are now coming from DIIs, and mutual funds, and these institutions aren’t expected to change their strategy as per FIIs,” said Divam Sharma, Founder and Fund Manager, Green Portfolio.
There is so much liquidity in the market that a slight correction makes financial institutions buy more even if at highs, added Sharma.
Foreign investors may drain some money from the Indian market in case of rate cuts, especially if they feel that growth opportunities may be better in the developed markets or safer assets, added Singh.
Retail Strategy
Retail investors who are loaded with the dopamine of frequent fresh highs should supposedly pause crafting further short to mid-term strategies.
"While, the rate cut can benefit sectors like real estate due to increased property demand from cheaper home loans, automobiles, consumer durables, infrastructure and capital goods, Investors should be cautious of sectors like banking, which might face margin pressures, and over-leveraged companies that may struggle in a volatile environment,” said Narinder Wadhwa, MD and CEO, Ski capital services.