Can Indian equities outperform global peers?

While the market may be vulnerable to lumpy outflows in the near term, it can emerge as a safe haven over the medium term.

Though most foreign investors had been underweight on India till recently, Indian equities, in effect, have performed better than some global peers. India is widely perceived to be an underperforming market this year, which is the case year-to-date. However, if we eliminate January 2011 — when the country lost 11 per cent on high inflation — it has not done badly.

It’s interesting to see how the tide has turned since January. After beating Indian equities, global pundits are trying to gauge the sustainability of this trend. However, as the global situation is still very fluid, it may be early to say India will come off unscathed. Analysts believe headwinds (inflation, policy paralysis, rising oil prices and tight monetary stance) are now turning into tailwinds. For instance, at 13.2x, the current valuation is 15 per cent lower than the long-term average and inflation should ease as oil corrects. Also, there seem to be visible action from the government on the policy front.

Another major irritant for investors have been the earnings downgrades, putting further pressure on valuations. Says a Morgan Stanley global research report, “A stress test of earnings shows the market may still be okay on absolute valuations. Currently, the equity risk premium implied by shares is reaching levels not seen since the 2008 financial crisis. Domestic liquidity tightness could have peaked and, usually, this signals a market trough. Our proprietary sentiment and market timing indicator are firmly perched in the buy zone.”

In 2008, earnings cuts were initially rather benign, at 3-4 per cent for FY09 and FY10. But, post Lehman, they were severe – 15 per cent for FY09 and 28 per cent for FY10. Manishi Raychaudhuri of BNP Paribas believes that in the present instance, cuts may not be as severe, as balance sheets are less leveraged and the key earnings drivers — commodity prices, bank credit growth — have not touched the high levels seen in January 2008. “We estimate worst case EPS estimate cuts to be 9-10 per cent for FY12 and 11-12 per cent for FY13.” Undoubtedly, India comes with its own set of problems. But, the advantage is the world is making it look rather good now. If the government fritters away its chance to act on reforms decisively, India could lose out to other emerging markets. With 18 per cent of the market owned by foreigners, it is vulnerable to lumpy outflows over the near term, says Citi, but in the medium term, it could warrant a safe haven status as global growth weakens.