Valuations remain stretched for Indian equities but foreign brokerages are optimistic that improved macros and the pick-up in corporate earnings growth may help Indian equities to end the year with gains. The elections might bring in volatility but are unlikely to bring sharp swings in the long run. Here are factors, they say, could impact Indian equities in 2019 :
The earnings growth recovery has proved elusive for the past several years now but foreign brokerages are optimistic. “While downside risk exists for our bottom-up earnings per share (EPS) growth forecast of 25 per cent for FY20 due to aggressive margin assumptions, we expect Nifty earnings growth of 18-20 per cent for the year, supported by a turnaround in domestic corporate banks,” notes CLSA. According to Credit Suisse, earnings growth has been accelerating and there is potential for further acceleration, especially in FY20, as the reforms start bearing fruit.
With the Nifty trading at 17 times one-year forward EPS estimates, and 11 per cent higher than the 10-year average, valuation comfort is lacking, observes CLSA. India’s premium to other EMs is at 66 per cent compared to the historical average of 37 per cent, according to Credit Suisse. “We believe valuations look a bit stretched compared to other markets now and Indian equity markets run the risk of a higher derating. Moreover, a potentially weaker mandate for the new government in the 2019 general elections could also lead to some P/E derating.”
In general, the last three election years have been positive for Indian equities. Credit Suisse says that long-term investors should look past potential election-driven volatility and leverage any sharp drop in share prices to build exposure in select equities. According to Deutsche Bank, most consistent relative outperformers pre-election include consumer discretionary, energy, and industrials and most consistent relative outperformers post-election include IT Services. “In general, global sectors have typically performed relatively better post the election,” says Deutsche.
Mid-caps versus large-caps
The Nifty MidCap's current price-to-book valuation of 2.3x is largely in line with historical averages and the valuation differential vis-à-vis large-caps is near one standard deviation higher compared to the historical range, observes Deutsche Bank: “Mid-cap valuations typically tend to be overly influenced by domestic investor sentiment. In the absence of a meaningful sentiment booster and with political uncertainty, we would expect the underperformance to continue in the near term.”
At a 2 per cent discount to India’s Nifty, CLSA believes mid-cap valuations look more reasonable compared to all-time highs seen in December 2017 (a 43 per cent premium). “We expect mid-caps to face bouts of volatility in 2019 given macro uncertainties and spread in headline earnings growth for Nifty midcaps vis-à-vis Nifty narrowing in FY20.”
Global liquidity tightening
Central bank balance sheets are expected to shrink by more than $400 billion in the next 12 months and by nearly $900 billion in the next two years, according to Credit Suisse estimates. A rising tide lifts all boats and the global liquidity has boosted Indian stock valuations as well. However, this is unlikely to continue. “If EM is now under pressure due to deteriorating global macro/lower liquidity, India is very likely to be affected by the same concerns,” says Bank of America Merrill Lynch.