What the India premium tells us about the markets
Indian equity valuations have mostly been at a premium to other emerging markets, reflecting the country’s higher growth
Bloomberg estimates put the MSCI India one year forward price-earnings multiple at 18.6 at present. The last time this valuation yardstick was so high was in 2009, when the markets were recovering from the global financial crash of 2008.
But it isn’t just the Indian stock market—markets everywhere show high valuations. The MSCI Emerging Markets index is also at valuations comparable to those last seen in 2009. The MSCI Asia ex-Japan index has a higher valuation now than what it had in January 2008. And the MSCI World index, which tracks developed markets, has a PE multiple higher than anything seen in the last 10 years.
So the Indian markets are rocketing up in tandem with global equities.
Indian equity valuations have mostly been at a premium to other emerging markets, reflecting the country’s higher growth. At present, MSCI India is valued at a premium of 35% or so to the MSCI Asia ex-Japan index, which represents the region. That is not a particularly high premium for recent years—it was over 40% for much of 2014, 2015 and 2016, even going above 60% in August 2015, as the accompanying chart shows. We have the same story with the MSCI Emerging Markets index, with the Indian market’s current premium over it being lower than what it used to be over much of 2014, 2015 and 2016.
A look at the recent history of the India premium over MSCI Asia ex-Japan is interesting. Between the middle of 2015 to mid-2016, the premium remained well above 40%. The decline started in June 2016 and by September that year the premium had fallen below 30%. Demonetisation hurt the India premium, making it go down to 22%. The introduction of the goods and services tax (GST) delayed the recovery, but by October last year the premium was back above 35%, which is the current level.
It’s no coincidence that the India premium was so high in 2015, when crude oil prices fell and India’s GDP growth went to 8%. By mid-2016, the windfall from falling oil prices disappeared, the banking sector developed deep cracks, India’s growth came down and so did the India premium. After the twin blows of demonetisation and GST, it is only now that the premium has started creeping up again, in the hope that growth will soon rebound.
In the last six months, the one-year forward PE for MSCI India has moved up from 17.6 to 18.6. Over the same period, MSCI India’s valuation premium over MSCI Asia ex-Japan has gone up from 33% to 35%. In other words, almost all the rise in valuation in the Indian markets is due to circumstances affecting the entire region. It is to global factors therefore that investors must look for signs that the party is ending.
This doesn’t mean that valuations are not high. But they are high across the world and have little to do with India-specific causes. The global rally reflects investors’ belief in Goldilocks—the belief that the scenario of above-trend growth and below-trend inflation will continue. The rally has been fuelled by very low interest rates in developed markets and the revival of global growth has given it an additional boost. Investors also believe central banks will do their best not to rock the boat. Indeed, the story of the last 10 years has been the story of the developed markets. In January 2008, the premium enjoyed by MSCI India’s valuation over that of MSCI World was 55%. Now, it’s 9%.