Equities to retain P/E premium over EM peers, says Credit Suisse

India’s investment appeal among global investors has improved materially, given improved corporate balance sheets, focus on reforms, record foreign exchange reserves, and a good momentum on tax collections, says a report by Credit Suisse.

This improved outlook is clearly visible in India’s record-high price-to-earnings (P/E) premium over other emerging markets: The MSCI India trades at a 12-month forward P/E premium of 83 per cent versus the MSCI Emerging Markets Index, compared to the 10-year average premium of 42 per cent. Indian equities outperformed major global equities with the Nifty Index gaining 5.2 per cent compared with the MSCI World’s returns of 1.8 per cent in the last month (see table).

The medium-term outlook for equities remains positive but some caution is warranted in the short term, the brokerage said.

“While this high valuation could unnerve some investors, we suggest staying invested in equities, albeit with reduced portfolio risks. We are now moving away from our long-held relative preference for mid-cap stocks, toward a neutral view. We are raising the relative weight of Indian mega caps to neutral as well,” the brokerage’s recent report, authored by its head of India equity research Jitendra Gohil and equity research analyst Premal Kamdar, said.

The analysts expect some underperformance by Indian equities, given stretched valuation. Nevertheless, they expect the equities to command better valuation premium over EM peers.

Foreign portfolio investors (FPIs) have been net buyers of Indian equities so far in August with net inflows of $870 million, after being net sellers in July. India will remain attractive for FPIs as its structural outlook has improved, and it offers very high growth among major economies. Meanwhile, domestic mutual funds recorded the fifth consecutive month of inflows as investors remained optimistic about the Indian equity market.

The Q1FY22 results were weak, in line with expectations, impacted by the disruption caused by the second wave of Covid-19.

However, the brokerage expects earnings to recover from Q2, largely driven by reopening trade and pre-festive buying starting early September. Beyond the Q1 blip, earnings momentum is expected to remain resilient, supported by a strong recovery in the second half of the fiscal.

“We expect the gradual reopening of the economy and the consequent impact on corporate profits in the next couple of quarters to keep investors’ interest high in well-managed private banks. The progress of the monsoon in India this year is somewhat slower than expected, and inflation might be an area of concern in the next few quarters. Hence, within the debt market, we are a little conservative, keeping a preference for short- to medium-duration bonds,” the analysts observed.

India’s exports are starting to pick up nicely and fiscal deficit may not be as bad as feared based on our assessment of the impact the second wave of COVID-19 has caused, the brokerage added.