The sharp run-up in the stock market has left many investors wondering whether valuations have once again started going out of hand. In a recent note, Citigroup Inc. has tried to gauge how expensive markets are, based not on current price-earnings (P-E) multiples but on P-E multiples at the middle of the business cycle.
According to Citigroup analysts Markus Rosgen and Elaine Chu, “The three markets in Asia ex (Japan) that appear cheapest based on mid-cycle earnings are Korea (a 49% discount), Thailand (42.7% discount) and Australia (42.3% discount). The biggest change over the course of the last three and six months has been Taiwan where the discount has narrowed significantly to just 12.9%. The other big mover is India, which is currently on a 9% discount to the mid-cycle earnings stream.”
In other words, seen from this perspective, markets which are trading at a substantial discount to their mid-cycle P-Es are cheap, while those where the discount is low, such as India, Hong Kong and Malaysia, are expensive. Citigroup is thus underweight India, Hong Kong and Taiwan, because these markets have run up substantially in the last quarter.
That hasn’t proven to be a deterrent to fund flows so far, though. In May, the MSCI India index rose a huge 36.63%, easily the best performer among all the developed and emerging market country indices. Contrast the rise of just 5.23% in May for the MSCI US index. For the three months to end-May, MSCI India’s rise, at 83.17%, was second only to MSCI Russia, which is up 91.14%.
But there has been a rotation away from China recently. Fund tracker EPFR Global points out that while investors continue to commit large amounts of funds to emerging markets during the fourth week of May, “There was a clear preference for more diversified exposure. China’s story exerted less of an influence on flows this week, with China Equity Funds absorbing a nine-week low of $18 million (Rs84.78 crore), as investors spread their cash widely and, for the most part, thinly.”
Could Asian markets go higher, despite their recent outperformance? They could, according to a Citigroup note dated 29 May. The note says that “with the resumption of strong inflows to Asian funds since the first week of March, yet cash weights remain at 2.9%, they are fully invested in our view.
“GEM (global emerging markets) funds, by contrast, see cash levels at 3.7%. With GEM funds still largely underweight Asia, and taking in more new money than Asian funds (65% more this week), by the time they unwind their position it could provide further liquidity to the region.”
But apart from the liquidity flows, Morgan Stanley’s Ridham Desai gives another reason why the Indian market could continue to be attractive despite high valuations. He writes, “On a relative basis, valuations do not appear attractive. The market is trading at a 50% premium to emerging markets compared with its long-term average of 8%, its recent low of 23%, and its January 2008 high of 105%.
India would need to grow earnings faster than the rest of the emerging world to justify these multiples. We think this is quite likely and hence believe that India will likely outperform emerging equities.”
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