Why is Indian markets premium losing its sheen?

In September, Sensex has fallen 1.41% after a decline of 2.41% in August. Photo: Hemant Mishra/Mint

Mumbai: Indian markets’ premium to other global markets is narrowing after the sharp decline in the last two months. MSCI India is trading at a 3.86% premium over MSCI World, a sharp drop from a 10.93% premium it had on 28 August, the highest ever touched this fiscal.

Price to earnings (PE) ratio of MSCI India is at 17.21 while MSCI World is at 16.57, which makes India still one of the most expensive markets among peers. However, valuations concerns have started to worry foreign investors, leading to withdrawal of global funds from domestic markets. 

In September, Sensex has fallen 1.41% after a decline of 2.41% in August. So far this year, both Sensex and Nifty are up 17-19% while MSCI India has gained 17.59% and MSCI World 9.52%. 

According to Macquarie Capital Securities India (Pvt) Ltd, foreign institutional investors (FIIs) were getting worried in general over Indian markets as well as financials trading at expensive valuations and some of them have cut their overweight positions to neutral. “Issues like job creation, weak state of the banking system and challenges in recovery in capex cycle were the most important concerns. While financialisation of savings is an emerging structural theme, current fundamentals don’t support such valuations, as per the FIIs,” said Suresh Ganapathy and Nishant Shah, analysts at Macquarie in a report on 25 September. 

Last month, FIIs sold around Rs99,327.02 crore of Indian equities crore while domestic investors including mutual funds and insurance companies kept the liquidity inflow intact. In September, domestic investors pumped Rs79,160.5 crore into the local markets. 

Stretched valuations, slow earnings recovery, fears of fiscal slippage, weakening growth and the US Federal Reserve’s hawkish monetary policy stance and rising geopolitical risks have impacted Indian markets in September. Gross domestic product (GDP) dropped to a three-year low of 5.7% in the quarter ended June amid continuous earnings downgrades by analysts. According to Bloomberg estimates, since beginning of FY17, Sensex’s expected earnings for the current fiscal and the next have been slashed by 9.4% and 4.4%, respectively. 

“India is an underweight due to its high valuations and weak earnings outlook, while the unintended impact of the goods and services tax (GST) reform coming through as higher inflation should not be ignored,” said DBS Bank Ltd. 

It said excess global liquidity is under question as markets catch up with US Fed’s policy normalisation plans. The US dollar and rates are reasserting their strength after the Fed affirmed plans to hike interest rates in December and continue normalising policy in 2018. 

“After a strong run this year, the Indian financial markets have lost ground in the past week. Much blame can be laid on the door of domestic triggers but are equally affected by a reversal in two global tailwinds—oil prices and easy global policies,” DBS said in a note on 28 September. 

However, many analysts think that corrections in the Indian markets are temporary and valuations will appear reasonable once earnings growth recover after initial transitory hiccups due to GST implementation. “Market valuations, when assessed on a PE basis, look rich largely due to a depressed earnings cycle. This has fuelled fear among market participants that we are nearing the end of a bull cycle. However, we have reason to believe that short term corrections notwithstanding the markets are not extremely stretched, and the Indian markets are not nearing the end of the bull cycle as of now,” said Anup Maheswari, chief investment officer, equities at DSP BlackRock Investment Managers Ltd.

According to Maheshwari, over the next couple of years, a good pickup in earnings growth can be expected from the low base of interest rates that has been created. “Indian markets are at a 14-year low in terms of corporate profits to GDP. Therefore, on the basis of fundamentals, there is, therefore, enough evidence to believe that the Indian markets are unlikely to go through a correction of the magnitude it witnessed in 2008,” he added. 

Gautam Chhaochharia, head of India research at UBS Securities believes concerns over a big revenue shortfall is overdone, though the research firm has been more cautious than most investors over the last three years on the recovery in India’s GDP and earnings. “The markets are again pricing in too much growth too soon in hopes of a demand recovery in second half of the year. As per our survey, consumers may be in the same boat as markets: sentiment is improving, but the actual underlying trends are not. In our view, the risk-reward for Indian markets remains unattractive, given our base-case December 2017 Nifty target of 9,000 and upside scenario of 10,000,” he said in a note on 25 September. 

Morgan Stanley expects India to continue to be among the world’s best-performing markets, with a potential 24% compounded annual growth rate (CAGR) in US dollar returns over the coming five years. “We expect such a return to be driven by acceleration in earnings growth (12% CAGR, 2017-27, in US dollar terms), as well as by multiple expansion,” it added.

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