Indian stock market could remain subdued in the short term

The stock market has exhibited a subdued tone over the last 1 ½ months, characterized by a decreasing threshold with a negative slope and a minor consolidation ranging from 3-4%.

This muted trend is expected to continue in the near term due to both global and domestic factors.

On a global scale, the currency market's volatility is a prominent concern, driven by the US credit rating downgrade and an economic slowdown.

The persistence of hawkish monetary policy and a risk of more US Fed rate hike are significantly influencing the market sentiment.

This impact is compounded by elevated inflation and economic deceleration, leading to a reduction in capital expenditure.

Consequently, there has been an escalation in bond yields, casting a shadow on equity assets.

Domestic concerns are high food inflation, dry temperatures, and the risk of El Nino.

This eventually is warranted to inch consumer prices and effect demand from the rural and middle classes.

The CPI level will tolerate, above the RBI target leading to an elongated high interest rate cycle.

However, corporate earnings are forecast to remain buoyant in Q2 due to a moderation in international costs (fuel, metals, and chemicals) and festival demand.

The upswing in retail inflation observed in July at 7.44% warrants careful observation due to its potential upward risk.

The possibility of heightened volatility looms if the inflationary pattern persists into August, September, and Q3.

Investors are displaying caution as bond yields gain traction, emerging as appealing high-return investments.

This involves reallocating from equities to bonds. The US 10-year yield has progressed to 4.2% from a three-month low of 3.7%. Similarly, India's 10-year yield has advanced from 7.0% to 7.2%.

Broadly, elevated inflation and interest rates influence both corporate earnings growth and valuation.

However, the perspective is that India's situation is set to be alleviated by steadfast domestic demand and increasing global orders from China plus strategy.

But invariably, high interest rate for a long time will have an impact on valuation.

India’s one year forward P/E valuation has grounded during the year from 20x to 18.2x, possibly more to go.

Nonetheless, the susceptibility of the domestic market is balanced by comparably lower FII divestment in India in comparison to other emerging markets, along with robust purchasing activity by DIIs and retail investors.

Increased divestment is evident in other emerging markets (EMs) due to concerns about deflation and potential default risks in China's real estate and financial sectors. 

Recent uptick in selling of US equities is linked to the downgrade of mid- and small-sized banks in the US.