India equity market’s dominance is susceptible

The US stocks went into a tailspin as the US Federal Chairman Jerome Powell remained firm in taming inflation, which hit a 40-year high of 9.1 per cent. Even as it decided to compromise on economic growth, the US Fed, time and again, in the last few months, reiterated its aggressive policy rate hike, which now has risen to 3.15 per cent - the highest level since early 2008.

All fall down

Major US indices suffered: Dow Jones Industrial Average slumped 20 per cent year-to-date; S&P-500 24.10 per cent; and the tech-focussed Nasdaq fared worse by plunging 32.18 per cent.

The strategy was no different from that of other major central bankers, especially Euro zone and the result was the same, with Germany and France markets cracking over 20 per cent. However, the troubled UK’s FTSE was relatively stable, as it was holding up to regime change.

Major markets across Asia-Pacific region such as Japan, China, Taiwan, Korea and Taiwan too bore the brunt. However, Indian markets are relatively stable. Not only benchmarks Sensex and Nifty, even Midcap and Smallcaps fared better than most world indices. But, South and North American countries such as Brazil and Mexico even bettered India’s performance.

Now, the key question is how long Indian stocks will retain their dominance vis-a-vis major global markets. Analysts are sceptical about the sustenance of Indian stock markets’ outperformance.

India’s valuation premium to its Asian peers remains near all-time high, said BNP Paribas in a roundtable conference last week. “Amid slowing global demand, lofty market valuations, a slowdown in retail flows and lack of positive catalyst for our earnings estimates, we remain cautious on the overall market returns in the near term,” it added.

‘Earnings yield to 7.7%’

India is the only market other than the US where equity valuations are extended versus domestic bonds. “At about 2 percentage points, the difference between India’s 10 year GSec yield and the Nifty’s earnings yield is at a point at which negative equity returns usually ensue,” CLSA said in its India Strategy report.

The Nifty’s absolute PE is slightly below +1SD of its historical average and at levels where positive equity returns are usually not forthcoming. At the 98-99th percentile, India’s relative valuation to EMs and Asia ex-Japan is also near record highs, it further said.

“A simple mean reversion could drive a deep pullback: keeping US bond yields at 4 per cent, reverting to the 5-year average difference of 4.7 percentage points vs the Indian bond yield would take it to 8.7 per cent. The historical average difference of one percentage point vs earnings yield would take the Nifty’s fair earnings yield to 7.7 per cent, implying 13x PE, 30 per cent below the current 12M forward PE of 18.3x,” it added.

Short-term concern

According to domestic brokerage Geojit Financial, India’s valuation premium of over 100 percent over EM rivals is a bit discomforting. At high valuations, markets are always vulnerable to corrections, it said, but added the valuation is just a “short-term” concern.

“If the global economy escapes from slipping into a deep recession and if the Fed stops tightening with the terminal rate at around 4 per cent, there is a good chance that the Indian economy and markets will outperform,” it added.

Earnings are up 65 per cent in 2 years. FY23 Nifty earning is likely to be around 870 and at 18,000 Nifty is trading above 20 times. But soon the market would be discounting FY24 Nifty earnings estimated at around 980. This would be just above 18 times FY24 earnings and the valuation cannot be regarded as high. “Capital will chase growth and earnings and India is the best emerging market on these counts,” it further said.

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