At a time when the benchmark equity indices BSE Sensex and NSE Nifty are hovering at their record high levels, global brokerage firm CLSA believes that it is time to book profit from the Indian markets. Its concern ranges from rising energy and broader input price pressures applying downward pressure to margins to the withdrawal of RBI stimulus.
“We call time on the 20-month rally in Indian equities, lowering our exposure to India within an AC APAC ex-Japan portfolio to 40 per cent underweight,” CLSA said in a report. The BSE Sensex has gained 127 per cent to 60,686 on November 12, 2021 from the Covid low of 26,674, scaled on March 24 last year. Likewise, the NSE Nifty index has gained 132 per cent during the same period. Below are the 10 key reasons which CLSA thinks can put some pressure on the domestic equity market going ahead.
High energy prices
CLSA said that acutely high energy prices are typically consistent with the erosion of India’s external position, sustained episodes of rupee weakness, and ultimately Indian equities’ underperformance of regional equities.
Soaring input versus output cost pressure will erode margins
Evidence of corporates struggling to pass swiftly rising input costs – related to global energy price appreciation and pandemic-induced supply chain disruption – on to end customers threatens margins. Although this is a global phenomenon, this is particularly acute in India where the positive spread of WPI over CPI at 640bps is by far the highest in two decades.
Withdrawal of its stimulus programme
On October 8, RBI Governor Shaktikanta Das announced the suspension of the central bank’s Government Securities Acquisition Programme (quantitative easing) while maintaining the benchmark repo rate at 4 per cent. Banking system excess liquidity, which peaked at Rs 10 lakh crore in early September, has moderated to Rs 8.4 lakh crore by early November and is subject to further withdrawal via the RBI’s use of reverse repos. On CLSA economics team forecasts, Indian inflation will fade towards the RBI’s 4 per cent medium-term target by end-FY2024 (March) from an uptick to 6.2 per cent in March 2022, while they anticipate the first interest rate hike in April 2022 for a cumulative 50 basis points of tightening by March 2023.
Outlook for macro drivers suggest no upside
Four-fifths of MSCI India’s monthly US dollar price returns over the past two decades may be explained by the combination of monthly movements in India’s industrial production, M3 money supply, rupee exchange rate versus the US dollar and the headline US ISM survey. At present, this framework suggests a significant disconnect between the index level change warranted by momentum in these underlying variables and the actual index level to the tune of MSCI India appearing some 23 per cent overbought.
Absence of fresh marginal buyers for Indian equities
In the 12 months from April 2020 through end-March 2021, net purchases of Indian equities by non-resident investors surged by $38.4 billion (or by 1.8 per cent of total market capitalisation) versus a cumulative $8.7 billion recorded in the five previous years. Then since the start of April this year the pace of net foreign equity purchases slowed considerably and has started to modestly reverse for a cumulative $1.2 billion of net selling over the past seven months.
Risk of disappointment from demanding EPS outlook
As is the case for the majority of emerging markets at present, delivered EPS growth for India is positively surprising versus consensus expectations made 12 months ago. However, this is a particularly rare occurrence for India – a market in which consensus expectations have a well-deserved reputation for optimism. Indeed, the actual EPS growth outturn has disappointed relative to estimates for 83% of the time over the past 26 years and by, on average, a significant 14ppt margin. The only sustained episode of EPS growth surprise for Indian equities since the mid-1990s lasted for 24 months through 2006/07, averaging a 7ppt greater than anticipated growth outcome over the duration versus consensus forecasts.
The latest headline 25 per cent consensus 12-month forward local currency EPS growth estimate for India (for overall emerging markets it is 11 per cent) appears particularly demanding given 12-month trailing delivered EPS growth is running at 32 per cent.
Rich valuations
Trading on a 31.6 times cyclically adjusted P/E, India is currently at the most expensive earnings-based valuation since June 2008 at more than one standard deviation above its 18-year average of 22.6 times. This contrasts with overall emerging markets trading on less than half India’s multiple at 14.7 times, or cheap to its respective 24-year average of 16.6 times.
Anticipate INR pressure with an eroding external position
On CLSA economics team forecasts, India’s basic balance of payments position will move back into deficit from March 2023 onwards with a March 2024 estimate of -0.8 per cent of GDP (current account deficit of 2.5 per cent of GDP and net foreign FDI inflows at 1.7 per cent of GDP). They are projecting a commensurate weakening in USDINR to 78.5 by March 2023 as the Federal Reserve leads the way on the removal of ultra-stimulative monetary policy.
Limited credit growth caps potential GDP and thus EPS growth
CLSA forecasts loan growth in India to remain at or below the pace of nominal GDP for the medium-term as undercapitalised PSU banks continue to constrain Indian economic output as they struggle to meet the demand for credit extension.
Inferior value creation provides a headwind for outperformance
Sustained episodes of India’s equity outperformance of emerging markets have typically occurred with a backdrop of superior value creation (spread of ROE over COE) for India relative to the overall EM asset class. However, India’s value creation at 645bps is now 232bps inferior to that of EM.
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