Global stock market sentiment has been hurt by the escalating trade conflict between the US and China. In India, rising crude oil prices, persistent selling by foreign investors and the depreciating rupee are other negative cues.

In spite of that, the gap between India’s valuations and its emerging market peers has increased. In fact, the premium is at the highest level in this calendar year so far (see chart).

The one-year forward price-to-earnings (PE) multiple of the Indian equity market (MSCI India) remains elevated. Currently at 17.31 times, while the PE is lower than the peak seen in this year, it’s much higher than its Asian counterparts.

In contrast, the valuation of the MSCI Asia Ex-Japan index has been correcting in the past few days and currently stands at 11.87 times. The sharp correction in the Chinese equity market may have weighed on the overall valuations of the index.

India’s resilience is driven by strong inflow of funds by domestic investors, which has more than compensated the outflows by foreign investors. Expectations of a much-awaited revival in India Inc’s earnings in the June quarter are driving domestic inflows. That said, some stock market analysts do not see much scope for further re-rating, unless earnings meet expectations. According to Motilal Oswal Securities Ltd, all key markets continue trading at a discount to India. However, India’s RoE (return on equity) remains superior to most emerging markets, an important differentiator for valuation premium.

Still, the adverse impact of rising crude oil prices on the country’s current account deficit and trade deficit cannot be overlooked. Further, investors should be cautious about frothy sector valuations too. In a report dated 28 June, Kotak Institutional Equities pointed out that valuations have become quite extreme across and within sectors.

“Extreme valuations between sectors and within sectors may imply the market’s (1) short-term concerns about global and domestic macro uncertainty and (2) long-term conviction about the future of disruptors and the disrupted. We note that extreme valuations and views have a history of nasty surprises, the most recent being the sudden turn in the market’s opinion of the Indian IT and pharmaceuticals sectors, which had given up for dead not too long ago," said the report.