India races ahead of global peers
Outperformance pronounced since August, leading to surge in valuation premium
Most global markets often march in lockstep, but what has played out this year—especially since August—has stunned many on the Street. That’s because the Indian market has stolen a march over its emerging market (EM) and global peers.
For a second straight month, the Nifty has outperformed the MSCI World index by more than 6 percentage points (ppts), and the MSCI EM for a fifth straight month.
China’s equity market correction as a result of its regulatory crackdown has weighed on the performance MSCI EM index — where it has more than a third of weighting. The MSCI World index is dominated by developed nations such as the United States, Japan, United Kingdom, and France — all of whom have severely lagged India since August.
In August, the Nifty rose 8.7 per cent, while the MSCI World and MSCI EM rose just 2.4 per cent each. And that outperformance has continued into September as well, with the Nifty gaining over 4 per cent, even as the MSCI World and MSCI EM indices are down 2.1 per cent and 3.5 per cent, respectively.
Globally, investors have scaled back their bullish bets in recent weeks amid concerns of a spillover from potential default at China’s Evergrande, imminent taper by the US Fed and rise in infections due to the delta variant.
In India, factors like increased pace of vaccination, strong domestic and retail flows, reallocation of foreign flows from China and a sharp rally in large-cap index heavyweights have pushed the domestic market.
While India always commanded a premium over many peers, the recent outperformance has widened the valuation gap, prompting some experts to call for caution.
The price-to-earnings (P/E) ratio of Nifty is currently over 80 per cent more than the MSCI EM index, which is the highest since the 2007-08 Bull Run. Indian markets have traded at an average premium of around 40 per cent since then.
“The MSCI India Index currently commands a valuation premium of 85 per cent compared to the MSCI EM Index and 24 per cent compared to the MSCI World Index (versus 10-year average of 7 per cent). We continue to expect the higher P/E premium for the Indian equities to continue given the market’s improved fundamentals. India’s exports are showing a strong recovery, forex reserves are making new highs and more importantly the government’s tax collections so far are much better than expected. In terms of equity flows, too, India is showing remarkable resilience despite high valuations,” said Jitendra Gohil, head of India equity research, wealth management, Credit Suisse.
Gohil says investors could reduce some risk in their portfolio by cutting exposure to small- and mid-cap stocks, while adding more large-caps.
The Nifty currently trades at a 12month forward P/E of 23.3 times. On the other hand, the MSCI EM and MSCI World trade at just 13 times and 19.3 times, respectively.
Sanjeev Prasad, MD and co-head of Kotak Institutional Equities, says such rich valuations could lead to some correction. “The rich valuations of the Indian market and of most sectors after the sharp rerating in the multiples of most stocks from their pre-pandemic levels raise the prospects of a pullback in the market and/or modest returns for a ‘longish’ period of time,” he said in a note this week.
“However, we would rule out a severe correction in the market as potential bad news in the form of earnings downgrades (from global factors) and/or higher bond yields may not be bad enough.”