Indeed, this is also reflected in the increasing levels of redemptions from Indian mutual funds.
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But a number of market experts say while Indian equities are a dearer bet, they are not in bubble territory. “Based on headline valuation parameters such as the price-earnings multiple and implied equity risk premium, Indian equities are no longer cheap. But we are in no bubble,” said Neelkanth Mishra, managing director, co-head of Asia-Pacific strategy and India equity strategist at Credit Suisse.
According to Mishra, medium-term growth prospects for India are better than what investors are anticipating, and this leaves room for stocks to rise further.
“Current estimates assume FY22 gross domestic product to be around 1% higher compared to FY20; our case is this is likely to be higher by 3-4%,” he said.
It’s important to note that by FY22, even if the economy merely recovers to FY20 levels, profits of India’s listed firms may grow at a much faster pace. The brunt of the slowdown has been borne by much smaller firms, mostly privately held, according to Credit Suisse research.
Some analysts also point out that the steep decline in global interest rates is making current equity valuations look reasonable. This is because the rate at which future earnings streams are discounted is low. Also, equities are preferred as a relative asset class because dividend, earnings and cash flow yields are much higher than fixed income yields, analysts say. In simple terms, the cheaper cost of capital makes earnings prospects of companies look attractive.
That said, a key upside trigger for the Indian market remains a revival in earnings. Analysts are hopeful that with the gradual reopening of the economy, earnings growth will improve, albeit on a low base. According to Dhiraj Relli, managing director and chief executive officer at HDFC Securities Ltd, while there is no bubble in the Indian stock markets yet, earnings have to catch-up for these valuations to justify. He expects technology and banks to lead the earnings revival.
“Our FY21 Nifty earnings per share target is ₹495, and FY22 is 32% higher. For BFSI (banking, financial services and insurance), there were concerns on large-scale defaults, particularly by MSMEs. That has not played out so far. Retail loan book seems to be in good stead, credit cost is less of a worry, and collection efficiency has improved meaningfully. Also, a part of covid-related provisions made by banks may be reversed, so there can be some windfall gains. Banks are back in favour,” he said.
With fears of bad loans allayed, shares of some key financial companies have recently surpassed their pre-covid highs.
In spite of pricey valuations, India has been an outlier among emerging market peers in terms of foreign fund inflows. In November, FIIs invested $8.13 billion in Indian stocks, according to brokerage CLSA. In the 12 months from December 2019-November 2020, Indian equities have seen inflows worth $15.63 billion. Analysts said the factors that have led to massive inflows include a recent hike in India’s weightage in the MSCI emerging market index from 8.1% to 8.7%. Meanwhile, other key Asian markets have seen outflows during this span, showed the CLSA data. Nonetheless, the sentiment towards Asian markets has significantly improved mainly due to dollar weakness.
Still, some analysts caution that investors shouldn’t get carried away by the index breaking psychological barriers.
“During times of sharp rallies, people extrapolate the best of every trend. For instance, look at the IPO market—the latest issue of IPOs, the valuation premium asked is steep. This is just one example of the market’s unhinged optimism. Historically, a sharp rally supported by large FII inflows usually leads to correction. So, we suggest investors raise some cash in equity markets to benefit from periods of volatility,” said Sahil Kapoor, chief market strategist, Edelweiss Broking Ltd.
A key downside risk for the market is a sustained rise in inflation on the back of increasing commodity prices. Investors should note that the low-interest rate spell could end sooner than anticipated amid sticky inflation. Analysts said that would be a major sentiment dampener. “Globally, the reversal of fiscal and monetary stimulus and a rise in inflation are some key risks for the market,” said Mishra.
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