Market surge shines spotlight on valuations

By Ashley Coutinho

The sharp rise in the past month and a half has pushed up Indian equity valuations. After a painful first half, the Nifty50 rebounded 8.7% in July on hopes that the US Federal Reserve would raise rates at a slower pace, trimming the year-to-date decline to 1.3% .

The Nifty50 is now trading at 20.1x estimated FY23 earnings. The country’s market cap-to-GDP ratio based on FY23E GDP is 102%, well above its long-term average. by 79%. The MSCI India index is trading at a 116% premium to the MSCI EM index, above its historical average of 62%, according to data from brokerage Motilal Oswal.

“The Nifty at 15,200 was a good level to bet on. At the 17,400 level, and with an economic recession in major economies not yet over, I’m a bit nervous,” said Andrew Holland, CEO, Avendus Capital Public Markets Alternate Strategies.

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Holland thinks the global earnings forecast is too high and the ‘bad news is good news’ trade is based more on what happened in the recent past than what happened during the previous economic recession.

India received the most inflows into equities among emerging markets in July, after South Korea, according to preliminary data from the Institute of International Finance. China recorded the most outflows, to the tune of $3.5 billion during the month.

“We have always been expensive compared to other emerging markets,” said Harsha Upadhyaya, Chief Investment Officer, Kotak Mahindra AMC. “But Nifty50’s 2,100 point rise since June 17 has made valuations much less attractive. On top of that, earnings season hasn’t been so good when you look at the headlines.”

Upadhyaya believes that a decline in earnings from FY23 figures is likely. However, if inflation slows over the next two quarters, analysts may focus on FY24 earnings. If that happens, current valuations may not look as high, he said.

“Indexes have risen too fast, too soon assuming inflation will decline in a quarter or two and global central banks will pause rate hikes. But it may take several months or even a year, to the Fed to control inflation,” said Mrinal Singh, CEO and CIO of InCred Asset Management.

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“In the meantime, businesses will face pressure on margins and earnings growth. EPS for most Nifty companies has already been downgraded by analysts for the current year,” he added.

Large caps are better positioned relative to mid and small caps on the valuation front, and may be better positioned to weather market volatility, market watchers said.

“We are more focused on domestic companies in the current environment and are overweight cement, industrials, autos and big banks. Valuations are well below historical levels in these segments and there is room for a further rise in valuations if the economy stabilizes and earnings improve,” Upadhyaya said.

Things are looking up for banks as asset quality issues ease and credit growth picks up. Automakers could do well in the coming quarters as commodity prices decline, demand picks up, especially in the passenger vehicle sector, and the chip shortage problem becomes more manageable. Infra-related industries and other sectors could do well if the investment cycle picks up.

According to Singh, growth will be driven by the manufacturing side of the economy over the next three years. “The PLI program has created a good incentive for businesses and the China plus one sentiment has created a strong push in demand. Capex-oriented sectors that cover manufacturing, capital goods and utilities could be the main beneficiaries “, did he declare.

Upadhyaya is wary of sectors such as IT, FMCG, consumer durables and retail, which have significantly outperformed since Covid-19 lows. “These look expensive relative to their historical valuations and are unlikely to be repriced anytime soon,” he said.

Singh, for his part, believes that highly leveraged companies could remain under pressure amid rising interest rates and currency volatility. Those who depend on the United States and Europe for their business may also be affected, as these regions experience a prolonged slowdown or recession.

Analysts expect a limited market going forward, with data on earnings growth, inflation, commodity prices and central bank actions likely to provide major clues.