Claus Born, Client Portfolio Manager at Franklin Templeton, considers India as an investment destination after a challenging month for Indian equities which faced several setbacks.
In October, foreign investors withdrew more than 10 billion US dollars from Indian equities – the largest monthly outflow of capital since the outbreak of the coronavirus pandemic. The country’s two main stock indices also recorded their sharpest monthly losses in October since March 2020. The Nifty 50 fell by 6.2 per cent, while the Sensex recorded a decline of 5.8 per cent. At the same time, the rupee fell close to its historic low against the US dollar. Was it just a brief pause for breath in the long rally? Or the start of a longer correction?
The correction in the Indian stock market should initially be seen in the context of stock market developments across Asia – with the exception of Taiwan, all stock markets in the region were down in October. However, the correction in India was somewhat sharper than in some other markets, albeit from a high level after the strong performance since last year. The correction did not come as a complete surprise. There have been early signs of a cooling in the Indian economy’s strong performance and of some companies failing to meet profit forecasts.
However, as long as we do not see dramatic downgrades in earnings estimates on a broad basis, we do not expect a deep and prolonged correction in the market. While international investors experienced strong capital outflows in October, domestic capital inflows remained robust and far higher than foreign outflows. Indian investors’ interest in Indian equities appears to be unabated.
Despite the recent correction, the valuation level of the Indian equity market remains high. The MSCI India is trading at 24 times expected earnings, which is slightly above the level of the S&P 500 at around 23 times.
And stronger earnings growth in the Indian market. We therefore see hardly any significant overvaluation in the large-cap segment.
However, the situation is different for mid-caps – this market segment currently has a valuation level that is around 100% above the average of the past 10 years. For small-caps, the valuation level is still 50% higher than the average of the last 10 years. In these two market segments, higher valuations were justified in recent years due to higher earnings growth. However, we are currently seeing a tendency towards an adjustment in earnings momentum. This creates the risk that the valuation premiums for many small and mid-caps will not be sustainable over time.
Are the outflows in India related to China’s stimulus-driven economic policy, causing more investors to tactically reposition themselves?
“There have certainly been investors who have tactically repositioned themselves in response to the Chinese government’s announcements. In October, there were strong inflows into ETFs investing in Chinese equities, among other things. Until then, positioning in China had generally been rather weak. The announcement of economic stimulus measures has somewhat brightened investor sentiment regarding China, both abroad and in China itself. But overall, the Chinese market also experienced a correction in October.
With regards to the role played by the central bank’s current policy. In October, the Indian central bank left the reference interest rate unchanged at 6.5%. Interest rate cuts are still expected over the next few quarters. The timing of these depends on how quickly seasonal inflation in food prices subsides over the next few months.
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