In May-June 2006, the Sensex and Nifty plunged 30% as consumer inflation rose to 7.26%. In April 2022, consumer inflation remained sticky near an eight-year high of 7.79%, while the Nifty has declined nearly 7.4% in May amid heightened concerns over monetary tightening by central banks to contain inflation.
“The current correction reminds us of the sharp fall during May-June 2006 caused due to steep increase in inflation leading to fears of demand moderation because of a sharp policy rate hike,” said Pankaj Chhaochharia, analyst, Antique Stock Broking. “In terms of similarities, correction is led by metals and small cap, while defensives out-perform. However, key differences are FMCG within defensives have out-performed in the current correction, while IT services out-performed during 2006.”
Periods of high inflation are not conducive for the stock market as rising prices result in central banks raising interest rates and corporate earnings come under pressure.
The market breadth in May so far has been better than in 2006. This month, only 45% of stocks in NSE-500 underperformed compared to 70% in 2006. During the 2004-07 bull market, there were two sharp corrections of more than 30%.
FPIs sold ₹6,800 crore in May-June 2006, while they have already sold ₹22,000 crore since May 1, 2022. Despite the aggressive selling by foreigners, losses in the Sensex and Nifty have been moderated by the purchases from domestic institutional investors – mutual funds and insurers, which have been inundated with retail flows.
“The strengthening dollar and rising bond yields in the US can cause more FPI outflows while rising inflation in India and a hawkish RBI, coming from behind the curve, are also negatives for markets,” said VK Vijayakumar, chief investment strategist, . “However, a 30% correction from the peak is unlikely. If the market corrects another 5% from here, valuations will become attractive, and DIIs, HNIs, and retail investors will buy aggressively, preventing a sharp slide.”
