Indian equity valuations calm, but risks persist

The steam in Indian equity valuations has lost considerable steam due to the current turmoil in equity markets. The 12-month forward price-earnings (PE) multiple of India’s key benchmark, the Nifty50, is 17.3x, well below its 10-year average of 19.5x, according to data from Motilal Oswal Financial Services Ltd. Indian stocks by Foreign Institutional Investors (FIIs), the Nifty is down about 10% so far this calendar year.

“Expectations of aggressive rate hikes by the US Federal Reserve to tame inflation have led to strong (FII) outflows from many Asian markets, including India,” said Kunal Vora, head of equity research. Indian companies at BNP Paribas. As a result, key indices corrected and valuations fell.

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For the ninth consecutive month, FIIs were net sellers of Indian equities. In June, their outflows at $6.3 billion were the highest since March 2020.

Nifty’s valuation on the cyclically-adjusted price-to-earnings ratio (CAPE), which is adjusted for inflation, also softened. On this metric, Indian stocks are trading at 27.18x, data from ICICI Securities Ltd showed, below recent highs of more than 30x. The CAPE ratio was created by Yale professor and Nobel Prize-winning economist Robert Shiller and is therefore also known as the Shiller indicator. A high CAPE ratio means the stock is expensive.

However, what has changed now is that inflation is showing signs of slowing down. This can be explained by expectations of a slowdown in demand following interest rate hikes. Prices for commodities such as crude oil, palm oil, petroleum coke and soybeans are falling. “It remains to be seen how the US Federal Reserve will react to this and whether the quantum of expected rate hikes diminishes. This will be one of the factors that will determine the evolution of valuations,” Vora said.

U.S. bond yields fell sharply, signaling that fears of a structural rise in bond yields due to a sharp rise in inflation were premature, according to Vinod Karki, head of strategy at ICICI Securities Ltd. That said, Karki expects the US Federal Reserve to continue its interest rate hikes given that it has yet to catch up with bond yields. “The market has already raised interest rates, so we expect India’s valuations to stabilize at current levels, for now,” he said.

Interestingly, despite falling valuation multiples, India continues to trade at a premium to its Asian peers. MSCI India is trading at a one-year forward PE of 17x, Bloomberg data showed. This is greater than 11 times and 10 times the PE multiples of the MSCI Asia Ex-Japan and MSCI EM indices, respectively.

However, the valuation premium gap could shrink if the correction in Indian markets deepens due to increased FII outflows. Major benchmarks in Korea, Taiwan and Brazil fell more than 10% each in June compared to May, in local currencies, according to the Motilal Oswal report. Even the MSCI Emerging Markets Index fell 7% month-over-month (mom) in June, but an exception here was the Chinese stock market, which was up more than 7% month-on-month.

Meanwhile, the June quarter earnings season is a key event to watch. Kotak Institutional Equities notes that the bulk of the profit reduction over the past two months for the Nifty 50 index stems from the government’s decision to levy new taxes on metals and mining (export tax on the steel) and oil, gas and consumable fuels (export tax). on diesel and gasoline and excise duties on crude oil). In this context, comments from management, particularly on operating margins, would be crucial.

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