Markets have been undergoing severe correction for over a few months now. The Nifty benchmark index has corrected by more than 20% from its all time high and the broader market has seen much worst carnage wherein the good quality stocks have corrected by 40-50%.
Ongoing correction in the market is attributable to high inflation and higher interest rates to control inflation. Are these two factors actually responsible for the market correction? Let’s see how inflation and higher interest rates affect the market’s performance.
Nifty 50 has around 35% sectoral weightage to financial services. This is one sector that will benefit a lot from high interest rates regime, wherein the banks will have higher net interest incomes as most of the loans are floating and the increase in the interest rates would get passed on to the consumers besides getting higher returns on their reserves lying with RBI. Moreover, the Nifty financial services sector index has been flat over the last two years and not given any returns despite the Indian banking sector having best of the balance sheets over the last decade.
The other two sectors, namely, information technology and oil, gas & consumable fuel constitute around 30% of Nifty 50 with a weightage of 15.89% and 14.26% respectively. Both these sectors are not much affected by high inflation as higher inflation is good for the oil and gas sectors and the higher input cost gets passed on to the consumers. In fact, we have been seeing the energy prices going through the roof over the last few months. Higher interest rates will depreciate the INR and that would be getting more revenue for the IT companies. There is no slow down in the demand for IT services, either.
Consumer durables, both discretionary as well as staples, constitute around 17% of Nifty weightage. This is one sector that may have some negative effects of higher interest rates as they may not be able to pass on the higher input cost to the consumers immediately. However, over a period of time, the higher input cost gets passed on to the end consumers.
Healthcare and metals & mining have their share of 3.91% and 2.76% respectively in the Nifty 50. Health care is not affected by the higher interest rates and metal and mining are having their best times over many many years due to the higher commodity prices. With the Indian rupee depreciating more under higher interest rates, it would be immensely profitable for the pharma sector.
So, we have seen that the present environment of high inflation and high interest rates is actually beneficial to most of the Indian corporate sectors forming part of the Nifty 50.
- Though the fall of the market has been attributed to the high inflation and high interest rates, in my understanding, the markets have just latched on to these factors to correct themselves from oneway rise of 155% from the lows of Mar 2020.
- Markets have to come back to the long-term averages to provide an entry point to genuine investors.
- Equities are the hedge against inflation. Higher inflation means higher growth resulting in higher earnings. Higher earnings will definitely reflect in the stock prices, though it may take time.
- It’s difficult to say when the markets will bottom out, but the ongoing correction provides an excellent opportunity to start investing in the equities, either directly or through mutual funds. As we have seen in our analysis above, the higher interest rate regime is actually good for the equity investments. A classic example would be the great Indian bull run of 2003-2007, wherein, the markets initially fell by almost 25% on the reversal of the interest rate cycle in 2004, followed by a massive bull run for the next three years.
- Indian stock markets are expected to give growth in tune with the nominal GDP(real GDP+Inflation) going forward, which should be around 14-15%.
- If we are already invested in equities, it’s time to increase the exposure. If not yet invested in equities, it’s the right time to start the process. If we do not understand the nuances of investments, please take professional help.
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Disclaimer: This content is purely for academic purposes and not any kind of investment recommendations. Please do your own due diligence or take advice from your financial planner before making any investments. Mutual Fund investments are subject to market risk. Kindly read all the related documents before making any investments.