Is it different this time? Market and economy doesn’t appear overheated This week, India’s benchmark Nifty touched five digits for the first time ever. Are markets overheated? In USD terms, the Nifty is about 3% below the previous peak and 8% shy of peak valuations reached a decade ago. The market cap/GDP ratio is close to the average and lower bond yields partially explain the high PE. Several other parameters such as credit growth, earnings growth, inflation and foreign flows appear to be at cyclical lows so the economy is far from overheating. Several reforms/actions such as GST and financial inclusion are in place which argues for higher growth for longer. Housing affordability is the best in decades and a housing boom appears imminent. Sticky domestic flows should sustain multiples and market returns should follow earnings growth. External shock (viz potential shrinkage in the Fed balance sheet) appears to be the key market risk. A potential populist turn by the government, a surge in equity supply and delay in NPL resolution are the risks on the horizon from an India perspective. Nifty at a high but several market parameters sober q The Nifty is up 17% in the past 12 month but has underperformed the MSCI AxJ by 2ppt and is in-line with MSCI EM, in USD terms. Foreign flows are quite moderate as compared to 2005-07. q The current high PE is based on low cycle corporate earnings. q MSCI India PE premium to MSCI EM is 40%, within 5% of the long-term average. q Market cap/GDP ratio is reasonable at 90% as against 150% at the Jan-08 peak. q High-quality (ROE) stocks have outperformed, so no irrational exuberance seen as yet. The earnings yield–bond yield gap at 0.9ppt is still close to the 10yr average. Economic parameters do not show any sign of overheating q Inflation was at a low of 1.5% in June ’17 (4.5% in FY17) vs 6.2% in FY08. The RBI is still in a rate-cut cycle. In 2007, the RBI was already in tightening mode. q Corporate earnings growth averaged only 2% over FY15-17 against 24% over FY06-08. Corporate ROEs are also down by c.12ppt from the FY06-08 average to 13% now. The corporate earnings recovery cycle has yet to play out. q The capex cycle remains subdued. GFCF as a percentage of GDP is down 7ppt from its peak to 27% in FY17. Launchpad for growth revival in place q Political stability gives high visibility to policy continuity well beyond 2019. q The GST reform implemented on 1 July significantly improves the ease of doing business in India as multiple taxes reduce and inter-state business improves. q Financial inclusion has been a key gov’t priority and, with c.300m no-frills accounts opened in three years, formalisation of a greater part of the economy is happening. q Housing affordability is at a two-decade best and a multi-year housing boom appears imminent (link), helped by gov’t policies. What could go wrong? q We believe that the potential doubling of equity paper supply to US$15bn-17bn in FY18 would still be manageable given sticky domestic inflows. A surge in equity paper supply towards US$20bn is a risk. q Possible populist measures (viz the spread of farm loan waivers, stringent anticorruption measures) ahead of the May ’19 elections could impact business sentiment. This risk is low as Mr Modi strengthens his political position. q Delay in NPL resolution. q Mid-cap valuations have crept up and trade at an 8% PE premium to large caps. Any sharp correction here would be negative, particularly from the perspective of a domestic investor who has a mid-cap bias. q Escalation of the geopolitical situation at the India-China border.
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