According to Kotak Institutional Equities, the latest round of correction in Indian stock markets would test individual investors' enthusiasm for equities. The Fed's hawkish posture, as well as rate hikes by the RBI and other central banks, has produced a risk-off environment for equities. The Nifty was down roughly 1% today after an almost 4-percent correction last week.

"In our opinion, over the next few months, a combination of low market returns (if the market remains flat or declines) and rising fixed deposit rates may shatter individual investors' faith in equities." "Retail investors have been immune to rising bond yields and lofty market valuations, with return expectations anchored by previous high returns and 'risk' expectations anchored by low fixed deposit rates," according to Kotak's analysis.



Values in Indian markets are still high, and inflation will begin to fall (simply due to high base effect). However, according to the firm, a higher-than-expected oil price is currently the market's biggest danger. Domestic inflation is expected to start tapering off in the second half of FY23 as the base impact kicks in, while prices may remain elevated due to ongoing global and domestic supply-side concerns, according to Kotak. However, the brokerage does not believe that modest interest rate increases in India will result in significant demand disruption.

"Unless oil prices rise dramatically, domestic bond yields may be nearing their top." Even with oil at US$120/bbl, India can get away with another 70-100 basis point rate hike—a policy rate of 5.25-5.5 percent (now 4.4 percent) and end-FY2023 inflation of 4.5-5 percent is not a bad result. However, higher-than-expected oil costs put inflation at danger." Despite rising bond yields, Kotak claims that equity markets are only partially pricing in higher interest rates.



"The strong rise in global and domestic bond yields over the last few weeks suggests that bond markets are pricing in greater inflation and interest rates, even as numerous central banks have begun hiking rates to combat excessive inflation." Given the enormous spread between bond yields and policy rates in both the US and India, this is especially true," it added.

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