CLSA, Goldman Sachs join growing chorus of India's 'expensive' valuations

CLSA, Goldman Sachs latest to highlight concerns

Goldman Sachs and CLSA have become the latest foreign brokerages to join the growing chorus of India’s rich valuations, following a world-beating 30 per cent rally this year. They join Morgan Stanley, Nomura, and at least three others to sound caution on unfavourable risk-reward, given the high price-to-earnings multiple and growing headwinds.

CLSA’s Chief Equity Strategist Alexander Redman in a note titled Indian Equities: On Borrowed Time highlighted 10 reasons to book profits on domestic equities.

“We call time on the 20-month rally in Indian equities. 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 the Reserve Bank of India 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,” he said in a note dated November 12.

A day earlier, Goldman Sachs downgraded Indian equities to ‘market weight’.

“We believe the risk-reward for Indian equities is less favourable at current levels. We, thus, take profits on our India overweight,” said the brokerage.

Goldman believes Indian markets will “consolidate over the next three to six months and underperform the broader region”.

The underperformance, if at all, will come after a long spell. On a year-to-date basis, domestic equities have outperformed the MSCI AC Asia Pacific (APAC) ex-Japan Index by 56 per cent in US dollar terms. Indian markets are up nearly 2.5x in dollar terms through the March 2020 trough. The sharp gains have pushed valuations above long-term levels.

“India is trading on 31.6x cyclically adjusted earnings (versus 14.7x for overall emerging markets, or Ems), more than one standard deviation above its 18-year average of 22.6x, with investors paying more than twice the book multiple for Indian assets versus EMs, despite the market offering the same profitability,” says Redman of CLSA.

The slashing of ratings by foreign brokerages have put a leash on India’s red-hot market. In the past one month, the Nifty has declined 1.3 per cent, even as the MSCI AC APAC ex-Japan Index has risen close to 1 per cent.

Besides, positives such as decline in Covid cases, faster vaccination, hopes of a strong revival in the economy, and robust buying by domestic retail investors have underpinned the gains this year.  Since March, the net investment by mutual funds (MFs) has been close to Rs 65,000 crore (roughly $9 billion). Add to that, the robust buying by individual investors who invest directly in the markets.

These domestic inflows have helped cushion outflows by foreign portfolio investors, which have ebbed and flowed this year.

CLSA believes an imminent threat to domestic equities is moderation in domestic flows.

“The demand for Indian equities has primarily been domestically-driven this year. The pace of these purchases has also more recently begun to wane. Furthermore, with the equity allocation on average among Indian domestic MFs already the highest among EM peers (39 per cent versus the simple peer average of 19 per cent) and the earnings yield-to-bond yield ratio at just 0.7x being the lowest since May 2008, there is questionable incentive for an extended episode of the current domestic equity euphoria,” said the global financial advisory firm.

FOREIGN BROKERAGES SOUND CAUTION ON INDIA

“Rich valuations, high probability of earnings disappointment, and potential lack of marginal buyers add to our motivation to book profits on India”

CLSA

“We believe the risk-reward for Indian equities is less favourable. Thus, take profits on our India overweight”

Goldman Sachs

“We see valuations as increasingly constraining returns over the next three to six months, ahead of US Federal Reserve tapering, an Reserve Bank of India hike in February, and higher energy costs”

Morgan Stanley

“China has never been this cheap versus India. FTSE India is now trading at a premium of 95% to China — a record high”

HSBC

“We now see an unfavourable risk-reward, given the valuations, since a number of positives appear to be priced in, whilst headwinds are emerging”

Nomura

“In our framework, Taiwan, Australia, and India look unattractive, especially on valuations/earnings, and Association of Southeast Asian Nations generally looks positive”

UBS

“Near-term GREED & fear’s overweight in India looks vulnerable”

Jefferies