Predicting the stock market is difficult. A more prudent approach is to remain prepared for any eventuality.
The market has been range-bound for the last two years. Many investors are hoping for an uptrend in the Nifty if tensions in West Asia ease. But there is another possibility: a market crash.
This Equitymaster article examines that possibility and what it could mean for investors.
This is not a forecast
There is just too much money (i.e., liquidity) flowing into the Indian stock market. Foreign investors may have sold, but domestic investors have more than made up for it.
This means that the upward pressure on stock prices will remain intact as long as domestic investors keep investing. This will be the case even if the Nifty itself does not rise too much. We are not predicting a bull market either.
The Nifty has been in a broad 5,000-point range between 21,500 and 26,500 for the last two years and eight months, with periodic ups and downs.
So, preparing for both a correction as well as a sustained bull market could be the best thing to do. It doesn’t take much effort to prepare for a bull market. As long as you are invested in good quality stocks, you will do well.
But what about a bear market? Could the stock market crash…and if it does, then how should you prepare for it? Let us explore:
Will the bull market resume?
Well, the market has been range-bound for a long time. The reasons are many–high valuations of stocks, slowdown in consumer spending, geopolitical risks, the Iran war, trade-related uncertainties, rising crude oil prices, and more.
The market has not reacted too harshly to any of these concerns. Since covid, there has not been a meaningful decline. On a couple of occasions–Trump’s initial tariff announcement, Operation Sindoor and the Iran war–the market reacted negatively. But things went back to normal in a few days.
This was due to a simple reason–fund flows from domestic investors.
The market’s primary trend will remain up as long as the relentless flow of funds from domestic investors remains intact. The small corrections in between do not worry most investors.
Will there be a market crash?
There are a few valid reasons to expect a serious market correction. The first reason would be another major flare-up in one of the geopolitical hotspots of the world. This could be renewed military actions in West Asia or Ukraine, or a war over Taiwan.
If such a war ends quickly, the market will still rebound. Otherwise, the correction could be prolonged.
The other reason could be a potential recession in the US.
At the moment, financial markets are not expecting this. The markets believe that as long as consumer spending does not collapse, the US economy will avoid a recession.
But stranger things have happened in financial markets. If consumer spending in the US slows down sufficiently, the possibility of a recession cannot be ruled out.
This is something investors must watch out for.
Then there are other reasons like a spike in oil prices well above $100 per barrel or the US Fed changing its decision.
There is also a possibility that the trade deals signed by the US may break down.
How to anticipate a market crash
The correct way to think about market corrections or bear markets is to consider the valuation of the benchmark index as your guide. This would be the Nifty PE ratio.
Historically, whenever the Nifty PE ratio went above 25, it was a big warning sign of a stock market bubble, a serious correction, and even a bear market… at least in hindsight.
This doesn’t mean you should be complacent if the Nifty PE is 23 or 24. A Nifty PE ratio above 20 could clearly indicate that the market is expensive.
There could be specific stocks that are cheap or reasonably priced. However, whenever the Nifty PE gets close to 25, you should be on guard.
The Nifty PE has been between 20 and 25 for a long time now. This makes the stock market vulnerable to a correction.
Earnings growth has also slowed down. The market is betting on earnings growth picking up in 2027. Only time will tell if this expectation is justified.
The defining feature of a bear market is the overwhelming negative sentiment among investors. Put simply, investors sell their holdings in a bear market out of fear that stock prices will go down.
But this is not the case in the Indian stock market today.
Thus, we can conclude that as things stand, a bear market in 2026 doesn’t seem likely…but a market crash can’t be ruled out.
How to profit from a market crash
- Keep a cash reserve ready, i.e., don’t be fully invested in the stock market.
- Have a watchlist of fundamentally strong stocks ready. Keep it up to date.
- Be mentally prepared to buy the stocks on your watchlist when the market falls.
- When a correction happens, don’t invest all your money immediately. Spread it out over time.
- Wait patiently for the rebound. Don’t be scared by news headlines and sell early.
- Invest for the long term. It’s the best way to build wealth by taking advantage of a correction.
Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such.
This article is syndicated from Equitymaster.com