Why the Sensex is Falling

The stock market is a volatile animal. It's also unpredictable. Predicting its next move is next to impossible.

Intelligent investors and traders know that anyone claiming to successfully predict the market is lying.

Just look at the events of the last few days.

Everyone thought the market correction had ended. A bear market had been averted. And also, the Sensex could hit a new all-time high.

But that has not happened.

The last two days, Friday, 19 August and Monday, 22 August, have seen a sharp reversal in bullish sentiment. The BSE Sensex has fallen 1,500 points. The joy of seeing 60,000 on the Sensex last week has disappeared.

Now, it's not as if no one thought the market couldn't fall. At Equitymaster, we were cautious about the recent rise in the market. In fact, we wrote about why the stock market recover may not last.

But it's safe to say that many folks on Dalal Street have been rattled by this sudden decline.

So why is the sensex falling?

Let's find out...

#1 Recession Fears

It's common knowledge these days in the financial markets, that the western world is headed for a recession.

In fact, the US is technically in a recession already, even if they don't want to admit it. This is because the GDP growth in last two quarters has been negative.

There have been open admissions by leaders in developed world that their nations could be enter a recession this year. This includes most of Europe, Canada, Japan, South Korea, Australia, and New Zealand.

Russia will be in a deep recession this year largely due to western sanctions. It's unclear when the Russian GDP will start growing again.

And it's not just developed nations facing the threat of a recession.

Much of the developing world is in the same boat. The reasons for each country may be different but high debt seems to be the main culprit. Much of Latin America, Africa, and South East Asia are struggling to repay debt.

India's neighbours, Sri Lanka, Pakistan, and Afghanistan are in serious trouble. Even Bangladesh, touted as an economic success story, is in a tough spot.

If much of the world is likely already in economic difficulty, then why would stock prices go up?

#2 Rising Interest Rates

Inflation has been a huge problem for the world ever since the recovery began after covid hit in 2020.

This was initially due to supply shortages due to disruptions in trade caused by lockdowns. But then it became clear that many businesses had gone bust. This caused a huge problem of demand outpacing supply on a sustained basis.

World leaders realised they couldn't wait for supply to catch up to demand over time. That would take far too long. Inflation could not be allowed to persist for more than a year.

After all, politicians have elections to win. Thus, a slow and steady decline in inflation, from very high initial levels, was unacceptable.

This is why central banks arounds the world have a free hand in aggressively hiking interest rates. The goal is to quickly bring demand under control instead of waiting for supply to catch up slowly.

High interest rates drives people to invest in fixed income assets like FDs and government bonds. The money flowing into fixed income usually comes from withdrawing money from the stock market.

#3 Fear of Falling Corporate Profits

The policy or raising interest rates seems to be having an impact already.

People in both developed and developing countries have realised that the era of easy money, low interest rates, and government freebies due to covid, has ended.

Thus, they have been cutting back on consumption. This is having an impact on sales of corporates.

In India, many companies had raised prices in anticipation of high raw material prices. Thus, in the short term, they can protect their profit margins to an extent even if sales come under pressure.

However, if the slowdown continues beyond 2022, there is little they can do to prevent a decrease in profits. Aggressive cost cutting can only do so much. Ditto for reducing debt.

Many Indian firms have already reduced costs significantly and paid of a lot of debt over the last two years. They can't do it again.

This is the big fear in the market. If the slowdown in demand extends beyond 2022, estimates of earnings will have to be reduced.

In the market there's a simple equation: Lower earnings estimates = Lower stock prices.

#4 The Surprise Chinese Rate Cut

In a world of rising interest rates, the Chinese central bank cut its benchmark interest rate today.

This has triggered fears that the world's second largest economy is also heading into a recession this year. Even if China avoids a recession in 2022, a big slowdown in its economy will have a big impact on the world.

And if China does enter a recession, just like the US, most of the world will follow.

In such a scenario, India could be one of the bright spots offering growth in an otherwise contracting global economy.

#5 Conclusion

Difficult times lie ahead for stock market investors. But remember that the best bargains are always found in falling markets. Every recession, no matter how deep or long-lasting, give birth to an economic boom and a huge bull market.

Investors should pick stocks with great care paying close attention to company fundamentals, management quality, the situation of the industry and the company's position in it, as well as the valuations of the stock.

Happy Investing!

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. Learn more about our recommendation services here...