Indian Equities: Buoyant On Fund Flows, Tempered By Valuations
The key ingredient for outperformance will have to be earnings growth, however concentrated that is, writes Niraj Shah.
A lot has been said and written about the possibility of political stability leading to a significant rise in foreign flows and thereby a rise in the markets to near all-time high levels. In fact, the Nifty Bank, the banking index, has eclipsed all-time highs in the recent rally. That has led to a lot of indicators getting triggered which, in the event of a sombre market mood, would have led to alarm bells ringing.
- The Nifty, until Friday, was trading above overbought regions on the relative strength index indicators.
- India’s 12-month forward price/earnings multiples are still approximately 100 basis points above the five-year average.
- 12-month forward price/earnings-to-growth ratios have inched materially higher in some calculations.
Instead, we saw additional ammunition, in that large global brokerages have started to raise their targets on India and foreign flows hit two-year highs. Can this sustain?
Let’s contrast the present scenario with what happened the last few occassions when we had such buoyancy in India. First, valuations. As mentioned earlier, Indian markets have reached overbought regions, as per traditional technical parameters.
The RSI, as of last week, was over levels of 79, the highest in over 12 months.
Amongst Asian peers, India was the only market trading in the overbought zone, and is still higher than the rest of the pack. The Nikkei 225, Hang Seng, SE Thai, Jakarta Composite or MICEX are all trading well below the overbought territory.
India’s 12-month forward PE is higher than the average and makes India currently the most expensive BRICS market, over 600 basis points clear of the next most expensive market, which is South Africa. Yes, growth in India is better than the rest, but one still needs to see if indeed FY20 will be the year when earnings growth can make an actual comeback, or if still remains a story of ‘forever the bridesmaid, but never the bride’.
The last time such fund flows came into India was in March 2017. After strong outflows from October 2016 to January 2017, that February saw some FPI flows, followed by March 2017, which saw FPI inflows reach Rs 30,906 crore. That was the highest in 2017 and the highest in the history of Indian markets in this century. What followed was a period of strong momentum, with the Nifty moving up from sub-9,000 levels at the beginning of March to over 10,500 by the end of the year.
This year has had a strong resemblance to 2017 in terms of flows, with March having seen inflows of over Rs 27,000 crore so far. Strong FII inflows need not automatically result in strong market performance. Keep in mind, 2013 was a year which had very large FPI inflows of over Rs 1 lakh crore, yet the market merely consolidated for the entire year. That said, there's visible enthusiasm in the manner in which the flows have resumed. The only factor that has changed in the last 45 days is the assumption around political stability.
On balance, India is under-owned in the FPI basket, with India’s allocation in emerging market and Asia ex-Japan portfolios at multi-year lows.
While actively-managed funds may not be the larger participants, and instead might be ETF money now finding its way into India, it is still good news for equities and the currency.
Flows follow performance and valuations, in most cases. Valuations, as discussed earlier, seem fair-to-slightly-stretched. However, when the going is good, people tend to ignore small fallacies. In its rationale for the upgrading Indian equities, Goldman Sachs said it sees a Nifty which appears ‘fair’ in valuation terms relative to the macro and that it sees valuations likely to overshoot. HSBC speaks about how macro indicators like the fiscal deficit, inflation, crude prices, and valuations are lower than what they have been in peak-bull phases in India. Risks emanating from low growth, trade tensions, and Brexit are in the background versus expectations of earnings growth and political continuity.
The key ingredient for outperformance will, thus, have to be earnings growth, however concentrated that turns out to be. The consensus expectations are of 16-18 percent EPS growth in FY20. The bull in the market would be hoping it nudges the 25 percent estimate that HSBC believes will be reached.
In all, there is a small risk-on rally underway, with over 50 percent of the BSE 200 stocks trading above their 200-day moving averages. An analyst at a domestic brokerage house released a client note that spoke of an ‘Explosive Buy Signal’. While March 2019 may turn out to be the month with the highest FPI flows into equities since NSDL started recording data in 2002, seeing these ‘signs’ is the easy part. What’s difficult is trying to predict if this risk-on rally can last. Considering how stretched the valuations look, almost every factor at play needs to click for the markets to stay elevated. There can’t be any misses. But even if everything clicks, it won’t necessarily lead to investment gains.
The only two material questions which will determine how much money you make, are:
- For how long can equity markets outperform on the back of benign central banks, despite the world economy slowing down; and
- Whether the relatively undervalued midcaps and small-caps will outperform large-caps.
If you answer these correctly, my dear investor, you would have hit a pot of gold when we review the year gone by in the coming months.
Niraj Shah is Markets Editor at BloombergQuint.