Indian equities: Tide may turn

With valuations touching 10-yr averages, a pick-up seems imminent in H2 of FY12.

The last few weeks have seen several foreign brokerages hosting investment conferences in India to brainstorm on market outlook and trends. Global emerging market strategists across the board seem to be bearish on India. But that’s the official line. Off the record, most seem to believe the tide is set to turn for India later this year. So, don’t be surprised to see strategists going overweight on Indian equities over the next quarter or so.

So far, other emerging markets such as Indonesia, China, Brazil and Russia have scored over India, but with oil expected to hold on to current levels, the tide may well turn for India. The immediate trigger, however, for the Indian markets will come with the peaking of interest rates. If this happens, Indian equities will surely be back in favour.

While peaking of interest rates may act as an immediate trigger, there are several other factors that global strategists find “comforting”. First, valuations have moderated and now look close to fair value. The 18 per cent underperformance of the MSCI India versus Asia (ex-Japan) since early October has brought absolute and relative valuations close to average levels. In its strategy note, RBS says: “The MSCI India is now trading at 14.5x the 12-month-forward PE (10-year average 14.2x), putting it at a 24 per cent premium to the MSCI Asia ex-Japan (down from 36 per cent at the end of 2010).”

With headline inflation expected to stay close to 9 per cent till September, the risk of a negative surprise is limited. Also, with GDP growth slowing to 7.8 per cent in the last quarter of FY11 from 9.4 per cent a year earlier, it’s evident RBI’s actions are working. Consequently, RBS believes monetary policy tightening has run its course in India, and only 50 basis points rate rise is expected.

MSCI India Bloomberg consensus EPS for FY12 has declined 5 per cent since the start of 2011, reflecting above concerns. Strategists believe MSCI India could outperform the region from now on, as the underperformance so far has priced in much of the macro concerns. It is widely perceived that India is probably ahead of the region in dealing with inflation and the resultant growth slowdown. However, if the upside could come in the form of a pick-up in reform momentum and an increase in natural gas production at KG-D6, a key downside could come in the form of a negative surprise from the US. What’s lacking in this market is conviction, not fundamentals.