BackIndia’s market valuations are not in bubble territory: Manishi Raychaudhuri
Manishi Raychaudhuri, head of Asia (ex-Japan), equity strategy, BNP Paribas Securities, says Indian valuations are not in bubble territory, but appear slightly stretched
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Indian markets are at record highs. What is driving this rally? Is there more steam left in this rally, or will the party be over soon?
A combination of liquidity and better market sentiment has driven this rally. Almost $23 billion in foreign institutional investment (FII) flows have come into Asia in 2017 (year to date), and India has garnered the second highest—about $6.5 billion. That’s more than double the FII flows into India in the whole of 2016. Flows into mutual funds (MFs) have also been strong over the past 2-3 years, enabling MFs to more than neutralize the FII selling we saw in the month of April.
In the near term, however, a correction appears likely. India’s valuation premium over the rest of Asia and relative to the market’s own history has gone to between 1 and 2 standard deviations above the long-term average, while earnings estimates have continued to drift. In contrast, Asian earnings estimates have moved up significantly over the past six months, driven by North Asia.
Are Indian markets expensive at this point? Why or why not?
While Indian valuations are not in bubble territory, in our view, they do appear slightly stretched. MSCI India is trading at 12-month forward PE (price-to-earnings) of 16.6x based on Bloomberg consensus estimates, a more than 10% premium to the long-term average. Price-to-book multiples are in similar territory. We wouldn’t have been worried about this moderate valuation premium had earnings been expanding—but they are not. Consensus EPS (earnings per share) estimate have declined in India over past 3-6 months.
When and by how much will an earnings recovery happen?
Indian corporate earnings—as represented by the front line indices—have seen single-digit earnings growth over the past four years. In comparison, we expect a recovery in FY18 and beyond. In FY18, we think earnings growth should be 12-13%, followed by mid-teens growth in FY19. We expect the drivers of earnings recovery shall be consumption resilience, strong operating leverage and lower capital charges (particularly interest) due to lower interest rates which are beginning to transmit to corporate balance sheets.
Where does India stand in your EM/Asia preference? Why?
In our Asia ex-Japan model portfolio, we are overweight India. Even though we think a near-term correction may be in the offing, over the long-term we think India remains an excellent story. Consumption resilience, likely investment recovery and continuing reform momentum are the three key legs that this market is running on.
Will Donald Trump’s tax cut plans impact emerging markets in a big way? How much impact do you see on Indian information technology and pharmaceutical sectors from the US visa restrictions and protectionist policies?
Going by the policies adopted by the Trump administration in the first few months after assuming office, we think strong protectionist policies are not very likely in the near term because such policies have the possibility of increasing inflation in the US and triggering rapid appreciation of the US dollar. The latter eventuality, in turn, could militate against the US administration’s attempts to bring back manufacturing jobs onshore. However, even in the event that some protectionist policies are formulated, India should be relatively protected, compared with EM peers, because of the predominantly domestic nature of India’s economy.
Are geopolitical risks being ignored by global investors?
We believe investors are fully aware of the geopolitical risks. However, the consensus opinion of global investors indicate the risks of a disruptive dismantling are low.
What are the key risks to this rally in emerging markets, particularly India?
We believe the biggest near-term risk to the EM rally could arise from an unwinding of the reflation trade, triggered by moderating domestic demand in China and other large consumption centres. Deleveraging efforts and a clampdown on shadow banking in China have ignited some concerns. Some hard commodity prices—iron ore is an example—and other global demand indicators such as the Baltic Dry Index—have declined 15-30% over past 1-2 months triggering some such concerns.
Which sectors in India are you overweight and underweight on, and why?
Within India we like private banks with a retail focus, industrial companies and building material companies that are relatively deleveraged and consumer discretionaries, particularly autos.
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