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Indian equity markets have experienced a remarkable rally in the past three months, with the Nifty index surging more than 10% between March 24th and June 23rd. The index reached a new all-time high, closing at 18,856 on June 28th. However, this impressive performance begs the question of whether the rally is sustainable or built on shaky foundations.
If we look at the past performance of the Nifty index for a little longer term of one and half years, it has remained locked in sideways movements. It reached its peak in the second half of 2021, but since then it has failed to generate any significant returns. However, it is worth noting that earnings growth has continued during this period, despite the index's lacklustre performance. As a result, although the index recently reached a new high, its valuation has decreased relatively.
The market cap to GDP ratio, which reached 113% in FY 2022, has now declined to about 92% indicating a reduction in valuation. Currently, the Nifty is trading at 18.9 times its one-year forward earnings, which closely aligns with the historical average and is notably lower than the levels observed at the end of 2021.
Additionally, the premium of MSCI India (22.2x forward PE) over MSCI EM (12.9x forward PE) has decreased to 72%, which is broadly in line with the average premium observed over the past ten years. The Indian market is not as expensive as it was during the previous rally. This leads to the question of whether fundamentals have stayed intact or have deteriorated over the period.
In the latest quarter, earnings for companies in the Nifty index came in line with expectations. Furthermore, some of the headwinds from the previous year, such as higher commodity prices and supply chain issues, have dissipated, indicating a favourable environment for earnings growth going ahead.
Nifty EPS is expected to grow at 15% CAGR over the period from FY 2023 to FY 2025. This will support the market outlook as over a longer time horizon stock returns follow earnings growth. Another crucial factor that will support EPS growth is the balance sheet strength of India Inc as leverage is at a 15-year low. This will provide companies with the flexibility to cater to demand growth by incurring new capital expenditures.
Among the major economies, India stands out as the fastest-growing economy, showcasing its strong economic performance. In addition, inflationary pressures have been consistently moving towards the central bank's target of 4%, indicating a positive trajectory for price stability. Furthermore, it is likely that interest rates have reached their peak, suggesting a potential stabilisation of borrowing costs. These factors collectively paint a promising macroeconomic outlook for India.
As a result, FPI flows have turned positive since the beginning of this fiscal year. The encouraging economic outlook of India, coupled with reasonable valuations, will continue to allure foreign investors seeking opportunities. Simultaneously, domestic Systematic Investment Plan (SIP) flows into equity mutual funds have remained resilient, despite the lack of significant movement in benchmark indices over the past two years. This steadfastness indicates that retail investors continue to view mutual fund SIPs as an effective means of saving and investing.
The sustained SIP flows from retail investors are particularly promising as this indicates equities are becoming a core asset for the masses. Near-term market movement is usually dictated by the direction of flows, so continued interest from both foreign and domestic investors provides a solid foundation for the market's stability and potential growth.
However, there are certain risk areas that should be taken into consideration. A global economic slowdown could have adverse effects on India, as evidenced by negative export growth in recent months. Sectors that rely heavily on overseas demand, such as IT services have been missing out on the recent market rally. Another risk factor is the possibility of deficient rainfall due to the occurrence of El Niño. Below-normal rainfall in June and delayed arrival in some parts may hinder agricultural production, potentially leading to inflationary pressures and a negative impact on rural consumption.
Irrespective of risks, the Indian macro-outlook remains strong, especially amid persistent global macroeconomic uncertainties. From a valuation perspective, the market is currently at a reasonable level, indicating that it may sustain the new highs achieved and move in line with earnings growth expectations. Moreover, India is likely to remain an attractive investment destination over the next 10 to 15 years, as it continues its march toward becoming the 3rd largest economy in the world.
Mohit Ralhan, Chief Executive Officer, TIW Capital
