NEW DELHI: Foreign brokerages are downgrading Indian markets for being extremely expensive based on traditional valuation metrics, when compared to peers such as China and Japan in Asia.
The NSE Nifty is up 30 per cent in 2021 so far, while the BSE sensex is up 28 per cent, driven by financials, utilities, industrials and consumer discretionary stocks even as the broader MSCI Asia Pacific ex-Japan index has largely remained flat.
On Monday, Nomura downgraded India’s equity markets to neutral from overweight due to expensive equity valuations.
The Japanese brokerage firm prefers allocating to China and other Asean countries that have underperformed India in 2021. The brokerage feels while the upside is already priced in, headwinds could emerge that will prove to be risky in the future.
Nomura said 77 per cent of domestic stocks in the MSCI index are trading higher than pre-pandemic or post 2018 average valuations.
“We now see an unfavourable risk-reward given valuations, as a number of positives appear to be priced in, whilst headwinds are emerging. We, thus, downgrade India to neutral in our regional allocation and will look for better entry points given our still-constructive medium term view. We like China (significant under-performer seeing stabilising sentiment) and Asean (tactically laggard reopening play),” said equity strategists Chetan Seth and Amit Phillips in a note.
Ironically, in February Nomura had upgraded India to overweight, citing fiscal activism and declining Covid-19 cases.
“However, we think these positives are now adequately reflected in current valuations – that appear rich not only on absolute basis but also on relative basis. Even on two-year forward price-to earnings (PE) basis (incorporating India’s strong earnings outlook), India is trading at record high elevated premium relative to regional markets,” the analysts added.
What are the biggest risks for India?Elevated commodity prices, sticky core inflation and tentative signs of slowdown in demand are among the biggest risks for India.
Analysts at Nomura think if the current trend in prices of natural gas, crude, coal and electricity continue till the end of the calendar year, and increase by around 5 per cent till March 2022, then the potential impact on consumer price inflation (CPI) would be around 1 per cent.
Nomura not the only one
Nomura is not the only one advising clients to cut allocations to India. Last week, brokerage UBS echoed similar views and said India has become “unattractive” due to “extremely expensive” valuations when compared to the Asean countries.
The brokerage also said that earnings momentum is fading in India and there is less scope for an economic rebound this year, even as domestic stocks have outperformed markets like Indonesia by 31 per cent year-to-date.
Low real yield and expensive currency suggest some vulnerability for India in the tapering environment.
“India, like Taiwan, looks very poor on our scorecard framework. The relative valuation of India to Asean, two areas with similar growth dynamics and occasional perceived macro vulnerabilities, looks too wide to justify,” it said.
A Bank of America survey that was released last week showed global fund houses are underweight on emerging markets and want to cut exposure in the next 12 months, citing inflationary risks.
Global fund managers’ allocation in October to emerging market equities fell to the lowest level since September 2018, while allocation to US equities increased to the largest since November 2020.
In a newsletter titled Greed & Fear, Christopher Wood, the global head of equity strategy at Jefferies, has said India’s overweight position looks ‘vulnerable’.
What is triggering the market correction?
Rising fuel prices, inflation and high valuations are now triggering a correction in the market after months of record rallying.
While the sensex is down 1 per cent in the last five days, slipping below the 61,000-mark, the Nifty also slipped below 18,000 as experts are starting to caution investors because of stretched valuations and the impact of inflation on corporate earnings.
The BSE sensex last touched an all time high of 62,245 on October 19, but since then it has declined by 2 per cent.
More such calls for reduction of allocation to India is likely to result in further outflow of funds and a deeper correction in the markets.
Foreign portfolio investors (FPIs) have already turned net sellers by pulling out Rs 3,825 crore in October so far. FPIs had been net buyers for two consecutive months and had invested Rs 26,517 crore in September and Rs 16,459 crore in August.