Fair valuation needs correction or a price rise in the Stock Market.
A market correction is a dip between 10%–20% in a stock market index. Market corrections can be viewed as a healthy pullback.
If the stock market does not self-correct, several external and internal mechanisms can force valuations to realign over time. These include:
- If a company is overvalued, but earnings do not support the price, investors eventually realize this, leading to price adjustments and vice versa if a company is undervalued, strong earnings and growth will attract more investors, driving the price up.
- If central banks (e.g., the Federal Reserve) raise interest rates, borrowing becomes more expensive, reducing speculation and forcing overvalued stocks to drop and vice versa If rates are lowered, undervalued stocks might rise as liquidity increases.
- Companies can influence valuations by buying back shares when they believe their stock is undervalued.
- Dividend increases can attract more investors, boosting stock prices.
- Mergers and acquisitions often lead to a revaluation of the companies involved.
- Investors move money from overvalued stocks/sectors to undervalued ones, a process called Sector and capital Rotation.
For example, if tech stocks are overpriced, funds might shift into commodities or industrials, bringing valuations more in line with reality.
- When speculative euphoria fades, overvalued stocks experience slow declines or stagnation. As sentiment cools, undervalued stocks become attractive and see price appreciation.
- Governments may introduce taxes on speculation (e.g., capital gains tax hikes) or regulate industries to prevent bubbles. Policy changes (e.g., stimulus, tariffs) can impact company earnings, influencing stock prices accordingly.
- Hedge funds, mutual funds, and pension funds adjust portfolios based on valuation models.
- If stocks are too expensive, institutional selling pressure can gradually lower prices.
- Algorithms use valuation metrics to make trades, reinforcing pricing discipline.
- External Shocks & Economic Cycles, Recessions, geopolitical events, and financial crises often expose mispricing and force revaluations. Companies that were overhyped without real earnings tend to crash, while strong businesses remain resilient.
Conclusion
Even if the stock market doesn’t self-correct quickly, natural market forces, fundamental earnings, policy changes, and investor behavior will eventually drive prices toward fair valuations. A crash is not the only way; gradual corrections, reallocation of capital, and macroeconomic changes also realign stock values over time.
A market correction is a dip between 10%–20% in a stock market index. Market corrections can be viewed as a healthy pullback.
In these correction times Value- Investors do not panic.
