“Expectations of aggressive rate hikes by the US Federal Reserve to tame inflation have led to steep (FII) outflows from many Asian markets, including India," said Kunal Vora, head of India equity research at BNP Paribas. Hence, key indices have corrected and valuations have tapered.
For the ninth month in a row, FIIs have been net sellers of Indian equities. In June, their outflows at $6.3 billion was the highest since March 2020.
Nifty’s valuation on Cyclically-Adjusted Price-to-Earnings (CAPE) ratio, which is inflation adjusted, has eased, too. On this parameter, Indian stocks are trading at 27.18x, showed data from ICICI Securities Ltd, lower than recent highs of over 30x. The CAPE ratio was created by Yale professor and Nobel prize-winning economist Robert Shiller and thus is also known as the Shiller indicator. A high CAPE ratio means that stocks are expensive.
However, what has changed now is that inflation is showing some signs of easing off. This may be because of expectations of a demand slowdown following the interest rate hikes. Prices of commodities such as crude oil, palm oil, petroleum coke, and soyabean are falling. “It remains to be seen how the US Federal Reserve reacts to it and whether the quantum of rate hikes that is expected reduces. That will be one of the factors that will determine how valuations move," Vora said.
Bond yields in the US have pulled back sharply, signalling that the fears of a structural rise in bond yields because of a steep rise in inflation were premature, according to Vinod Karki, head of strategy at ICICI Securities Ltd. That said, Karki expects the US Federal Reserve to continue with interest rate hikes given that it still has to catch up with bond yields. “The market has already baked in interest rate increases, so we expect India’s valuations to stabilize at the current levels, for now," he said.
Interestingly, despite the drop in valuation multiples, India continues to trade at a premium to Asian peers. MSCI India is trading at a one-year forward PE of 17 times, showed Bloomberg data. This is higher than 11 times and 10 times PE multiples of MSCI Asia Ex-Japan and MSCI EM index, respectively.
However, the gap in valuation premium may contract, if the correction in Indian markets gets deeper on higher FII outflows. Key benchmark indices in Korea, Taiwan, and Brazil have fallen more than 10% each in June from May, in local currency terms, said the Motilal Oswal report. Even the MSCI Emerging Markets index slumped 7% month-on-month (m-o-m) in June, but an exception here was the Chinese equity market, which was up more than 7% m-o-m.
Meanwhile, the June quarter earnings season is a key event to watch out for. Kotak Institutional Equities notes the bulk of the earnings reduction over the past two months for the Nifty 50 Index has come from the government’s decision to levy new taxes on metals and mining (exports tax on steel) and oil, gas and consumable fuels (exports tax on diesel and gasoline and excise duty on crude oil) sectors. In this context, management commentary, especially on operating margins, would be crucial.
