Vijay Kumar Gaba

In January 2021, the 22^nd biannual Financial Stability Report (FSR) of RBI had raised many red flags over the Indian financial markets. The report, inter alia, highlighted the uneven economic recovery, accentuated credit risk of firms and households, and divergence between economic activity and asset prices. Commenting on the findings of FSR, the RBI governor had then cautioned investors and financial institutions that “The disconnect between certain segments of financial markets and the real economy has been accentuating in recent times, both globally and in India” and “Stretched valuations of financial assets pose risks to financial stability. Banks and financial intermediaries need to be cognisant of these risks and spillovers in an interconnected financial system.”

Incidentally, the benchmark Nifty has gained ~24% and total market capitalization of NSE has increased ~38% since release of last FSR in January 2021.

The economics team of RBI, in the latest monthly bulletin of RBI, has reiterated, “The Indian equity market has outperformed major equity indices in 2021 so far. The spectacular gains have raised concerns over overstretched valuations with a number of global financial service firms turning cautious on Indian equities. Traditional valuation metrics like price-to book value ratio, price-to-earnings ratio and market capitalisation to GDP ratio stayed above their historical averages. The yield gap (difference between 10-year G-sec yield and 12-month forward earnings yield of BSE Sensex) at 2.47 per cent has far outstripped its historical long-term average of 1.65 per cent.”

Expert opinion divided

Some prominent global brokerages have recently turned cautious on Indian equities. They have advised their clients to reduce exposure to Indian equities. For instance—

The global strategy team of CLSA advised lowering of India exposure to 40% underweight, citing 10 reasons for booking profits on India. It said, “We call time on the 20-month rally in Indian equities, lowering our exposure to India within an AC APAC ex Japan portfolio to 40% underweight. Our concerns range from elevated energy and broader input price pressures applying downward pressure to margins, the current account balance and thus currency outlook, the withdrawal of RBI stimulus, and a lack of upside implied by Indian equities’ typical macro drivers. Rich valuations, a high probability of earnings disappointment, and a potential lack of marginal buyers add to our motivation to book profits on India.”

Goldman Sachs lowered Indian equities to market weight after region-leading 31% gains in 2021. It said, “After gaining nearly 31% ytd and 44% since our upgrade in November last year, and being the best-performing regional market in 2021, we believe the risk-reward for Indian equities is less favorable at current levels. While we expect strong cyclical and profit recovery next year and remain medium-term constructive amid increasing digitalization in the index, we think the recovery is well priced at current peak valuations. We, thus, take profits on our India overweight and lower it to market weight within our regional allocations.”

Morgan Stanley also advised booking profit in Indian equities, despite retaining a structural positive stance. It said, “We move tactically EW on India equities after strong relative gains - we expect a structural multi-year earnings recovery, but at 24x fwd P/E we look for some consolidation ahead of Fed tapering, an RBI hike in February and higher energy costs.”

The “lower weight on India” is however not a consensus call. There are investors who are willing to look beyond the near term concerns and potential draw down in stock prices, and increase allocation to Indian equities. 

Mark Mobius, whose emerging market fund has over 45% allocation to Indian and Taiwanese equities, sounded extremely bullish on India, in a recent media interview. He said, “India is on a 50-year rally even if there are short bouts of bear markets.”

Another veteran, Chris Wood who writes famous ‘Greed & Fear’ report, recently wrote, “If GREED & fear is Overweight China, GREED & fear also remains structurally Overweight India. GREED & fear repeats the point that if GREED & fear had to own one stock market globally for the next ten years, and not be able to sell it during that period, that market would be India.”

Foreign investors continue to sell

Regardless of these divergent views on Indian equities, the foreign portfolio investors (FPIs) have been net sellers in six out of past seven months. So far in 2021, FPIs have net sold ~Rs240bn in Indian equities.

…as global investors’ preference veers towards developed markets

In fact, the global investors have been increasing weight on developed market equities for past many months. The latest global fund managers’ survey conducted by Bank of America (BofA) global research indicates that the global investors now have highest overweight on US equities since 2013

Promoters remain sanguine about their businesses

The recently concluded earning sessions did not throw up many surprises. The earnings were mostly in line with analysts’ estimates. The revenue growth was offset, to some extent, by higher raw material prices. The lower margins prevented any meaningful earnings upgrades. IT services companies witnessed strong earnings momentum and upgrades; while automobile manufacturers; insurance companies and chemical 7 paint companies witnessed downgrades. The results of financial stocks were also mixed.

As per MOFSL, “Key drivers of 2QFY22 performance: [1] IT- Indian IT services delivered one of its bestever quarterly performances with a sequential revenue growth of 4.8% (USD). Moreover, stable deal wins and the upbeat commentary on overall tech spending provide high visibility for future growth. [2] Oil & Gas (O&G) – The performance of OMCs was driven by a better-than-expected margin performance, led by both higher reported GRM and higher-than-estimated marketing margins. Sales volume witnessed a demand recovery post the second COVID wave. [3] Autos – High raw material inflation and operating deleverage impacted the sector’s 2QFY22 results. OEMs (MSIL, Bajaj and TVS) reported a commodity cost impact of 2-4pp QoQ, but expect semiconductor supply to improve from the 2QFY22 levels.”

The brokerage kept the Nifty EPS for FY22/FY23 largely unchanged at INR 731/INR873 (from INR 730/874).

A majority of the market participants however seem to be of the view that the present earnings estimates may be little ambitious to achieve and we may see more downward revision in 2HFY22.

Given the mixed signals from investors, corporate performance, policy makers et. al., the Indian markets have turned indecisive in past few weeks. The benchmark indices are moving in a narrow range waiting for clear signals to choose a direction. Volatility has increased and volumes are plunging much below the 12month average. Institutional participation is diminishing. The sectoral movements are sharp and random. Accordingly, the divergence in sectoral performance is stark. The strong response to expensively priced IPOs has added to the randomness of market behavior.

Next week, we shall have a look at market internals to discover more about the market behavior and likely outcome in the short term.