For the first time in its history, a survey by Bank of America Merrill Lynch has found that long positions in emerging markets (EMs) is the most crowded trade there. This is a sharp turnaround from the previous survey in January, when fund managers said that short EMs was the third-most crowded trade in the market. In the process, the long EMs trade relegated last month’s winner, long US dollar, to the second position.

A look at the returns of EM indices suggests the queues forming in these markets are indeed resulting in higher returns. On a year-to-date basis, the MSCI EM Index and the MSCI Asia ex-Japan Index have risen 7.91% and 7.66% in dollar terms, respectively.

But this optimism hasn’t rubbed off on Indian equities, which have underperformed EM peers so far this calendar year. The MSCI India Index is down 1.6% in dollar terms and 0.42% in local currency terms.

The valuation gap between Indian equities and emerging market peers remain wide.
The valuation gap between Indian equities and emerging market peers remain wide. (Naveen Kumar Saini/Mint)

While foreign portfolio flows have been marginally positive so far in CY19 at $355 million, alongside inflows of nearly $1 billion from domestic mutual funds, Indian equities have still been on the edge this year. This is because of a number of factors such as the liquidity crisis that is beginning to impact the financial position of promoters of some listed companies, political uncertainty and unexciting earnings growth.

Coming back to the apathy of foreign investors towards Indian equities, the main reason is their high valuations. Although valuations have moderated from their peaks, India remains an expensive bet. As the chart alongside shows, the one-year forward price-to-earnings (P-E) multiple of MSCI India is at 17.54 times, 50% higher than the P-E of the MSCI EM Index.

Another factor which could be keeping investors away from Indian stocks is the political uncertainty around the forthcoming general election. Besides, there are concerns about revival in corporate earnings. Morgan Stanley said in a report on 29 January, “Since the start of the earnings season, consensus for Sensex earnings per share growth is up 7 basis points (bps) for FY19 but down 136 bps for FY20." A basis point is one-hundredth of a percentage point.

Indeed, the rise in the P-E ratio of the MSCI India Index in the past year is largely because of earnings downgrades, rather than price appreciation.

Meanwhile, the Bank of America Merrill Lynch survey also pointed out that despite the recent rally seen in global equities, investor sentiment remains bearish.

What all of the above factors point to is while the crowded EMs trade may result in some positive flows to India from exchange traded funds (ETFs) that track these markets, non-ETF flows may continue to be volatile.