Dear Investor,
In this edition of the monthly update, we focus on the debate on Indian valuations vs that of the global peers. We believe that higher relative valuations in India are sustainable.
India is one of the better-performing markets globally, hence its weight in global indices has sharply gone up. Indian valuations are significantly higher than historic valuations relative to emerging markets, giving rise to the aforementioned debate.
We believe this is sustainable for the following reasons:
- In this period of global turmoil, India finds itself relatively better placed. Our forex reserves are amongst the highest in the world, with over 5 years of coverage of our current account deficit, which allows our central bank to have a higher degree of freedom vs central banks of countries with lower forex cover. Many of our competitors such as Pakistan, Bangladesh and Sri Lanka had to seek forex help from international agencies.
- While many countries are rolling out austerity measures, our economy is continuing to see business as usual. The level of forex reserves is a key competitive advantage. Our external debt is amongst the lowest. This makes our macros much better than most countries.
- Commodity prices have declined: Most commodities are now lower on a one-year basis. India is a net importer of commodities, particularly oil. Lower commodity prices will reduce the input cost thus increasing the relative attractiveness of India.
Source: Bloomberg, as on 13 Oct 22, Price Performance in USD
Disclaimer: The Graph/Table mentioned herein is for explaining the concept and shall not be construed as an investment advice to any party. The information / data herein alone is not sufficient and shouldn’t be used for the development or implementation of an investment strategy.
- Growth in some spaces is accelerating/ sustaining: Earnings Growth is a key driver of valuations.
- Financials: banks are witnessing stronger credit growth and NPAs are sustaining at a low level. This is making them key profit drivers for the economy. A large sector doing well helps the overall market. Banks are a large sector in most markets and many markets are not doing well. This does explain a part of the relative valuation issue.
- Chemicals: While many countries are benefitting from the China+1 sentiment, spaces like Chemicals in India are a strong beneficiary of the sentiment given the existing eco-system.
- Defence and geopolitics: With the geopolitical situation not normalizing, domestic armament production is now a focus and is a large import substitution theme. Our pharma sector should stand to benefit from the geopolitics of the day. Some of the emerging markets such as Russia are less investible just now and that impacts relative valuations.
- Engineering: With the revival in domestic capex, engineering companies have a better outlook. There are expectations of some shifts in global supply chains from Europe to India due to lower energy availability in Europe.
- Software services: Contrary to expectations, most IT companies are seeing growth sustaining. This space has a large presence in the index. After the correction, it should see valuations sustain. INR depreciation should help this space.
- Relatively stronger economic growth should sustain in India: Capex cycle in India is just starting with robust home sales, PLI-assisted corporate capex, and continued government capex. Healthy balance sheets of large corporates with low debt to equity and improved capacity utilization have increased business confidence, catalyzing the corporate capex. The shift of some European businesses to Indian subsidiaries may also help. While growth contributed by post Covid pent-up demand manifestation should normalize, the Indian economy should continue to grow better than others into FY24 as well. Aided by better pricing power on account of currency depreciation and import duty protection, the profit outlook is also reasonably strong despite declining from earlier levels.
- Large economies in Europe and America suffer from either lower availability of energy (Europe) or sharply higher interest rates and currency appreciation (the US) which is clouding the growth outlook.
- Retail investors structurally entering the market. From the beginning of the Covid period, retail investors have been structurally entering the market. This has helped lower the impact of FPI selling. In periods when FPI selling subsides, markets turn buoyant. In a period when FPIs and domestics both turn buyers, the markets are reasonably strong. The flows into equity funds and directly into the market should continue to be strong for a long period (though not linearly).
- Expectations on monetary tightening may need to be re-adjusted, this time in favor of a slower net reduction in liquidity/ increase in interest rates. The inflation data that is coming out is mostly backward-looking. However, policymakers continue to be focused on data and the regulated rate increase is now more than what was initially expected. USD 10yr which had subsided to sub 3% a few months back, is now close to 4%. Growth-oriented countries and businesses get impacted negatively by higher interest rates. The higher cost of money has caused sharp equity corrections in India as well. However, after the sharp up-move of the yield curve, a need for tempering down the pace of tightening is being appreciated. Lower commodity prices and hence a lower inflation outlook should help. This move, if it occurs, should help sentiment towards India.
This combination of factors is not presented in most other countries and hence justifies the premium for equities in India over them. Europe suffers from lower availability of energy, and America is seeing a sharp increase in mortgage rates and strong USD, leaving very few meaningfully large economies with the ability to grow and be relevant to growth investors.
Valuations
Markets have been in a band over the past year. This is in response to the slowing earnings growth outlook and continued monetary tightening.
With the economic slowdown, the expectations of earnings growth have come down for FY23. FY24 earnings realistically should now be lower and imply a forward PE of just about 18.5X at current market levels, which we believe is fair. Over time, the index composition has changed and the percentage of higher PE stocks has risen sharply. This implies that valuations should sustain over time. However, given the sharp up move in bond yields, equities currently look less attractive than bonds. This can change if the inflation and interest rates are expected to decline. However, for the time being, the market should continue to consolidate in a narrow range. It should continue to be a stock picker’s market.
Source: MOAMC Internal Research, Bloomberg, Data as on 14 Oct 2022
Disclaimer: The Graph/Table mentioned herein is for explaining the concept and shall not be construed as an investment advice to any party. The information / data herein alone is not sufficient and shouldn’t be used for the development or implementation of an investment strategy.
Quarterly results expectations for Q2FY23
Q2FY23 result season is on. Overall, our stock universe is expected to post a decrease in profits this quarter. Commodity space is expected to show a sharp de-growth with strong growth expected from Banking and Autos.
The first few results have been mostly in line and have been positively received by the market. Banks have delivered good results. Some IT companies have delivered better-than-expected numbers which are credible in the face of global slowdown and economic uncertainty. Cement companies have disappointed.
Alpha generation more probable in the future
Earnings breadth is increasing: Market price is a slave of earnings. Over the past several years, earnings momentum was displayed by a narrow set of stocks, and this created sharp polarization in the market. As a broader part of the market displays earnings momentum, the price performance is also broader and allows for alpha generation.
Index earnings grew slowly between FY2007 and FY2021. During this period larger cap Indices delivered better growth vs midcaps, clearly pointing to narrow markets. When growth started, large caps saw growth accelerate before midcaps. Growth is now moving towards the midcap segment of the market resulting in sharply better market breadth and alpha generation possibilities.
Heightened macro risk perceptions should normalize going forward: Covid period was a period of uncertainties. Given these uncertainties, active managers built a conservative portfolio and underperformed managers with close-to-index positioning. Russia- Ukraine war also impacted risk perceptions. Heightened risk perception as it normalizes should also result in better market breadth.
Broadening of market participants: There was a period when much of FPI flows was of ETFs and structural domestic EPF and Pension flow targeted close to large cap index positioning. This caused the index to perform relatively strongly while the broad market struggled. With strong and sustained inflows from retail investors in India, a trend we believe is structural given low asset allocation to equities, the breadth of the market should sustain. This provides alpha generation opportunities to managers.
Continued and strong pro-industry, pro-job creation, pro-domestic capability development focussed government reform momentum also provides a positive impetus.
I do believe if the above trends persist, and they should, the ability of managers to generate alpha should get a boost.
Our positioning Over the past few years, the market performance of high-quality businesses delivering sustained growth was significantly more than the earnings growth demonstrated, which has made this space very expensive. For example, the consumer space has delivered lower EPS compounding vs the Technology space but has seen a market cap compounding of 3% over profit compounding over 15 years. Technology space market cap compounding has been a tad lower than profit compounding. This has resulted in starkly different valuation outcomes for similar ROCE businesses. Our house is hence, now focused on spaces that have participated to a lesser extent in price compounding while offering a high-quality character. We believe that this space offers a much better risk-reward equation.
Disclaimer: The Graph/Table mentioned herein is for explaining the concept and shall not be construed as an investment advice to any party. The information / data herein alone is not sufficient and shouldn’t be used for the development or implementation of an investment strategy.
Happy Investing and Happy Festivities
Thank You
Prateek Agrawal
Executive Director – Motilal Oswal Asset Management
Disclaimer: This article has been issued on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this document is for general purposes only and not a complete disclosure of every material fact. The Stocks mentioned herein is for explaining the concept and shall not be construed as an investment advice to any party. The information / data herein alone is not sufficient and shouldn’t be used for the development or implementation of an investment strategy. It should not be construed as investment advice to any party. All opinions, figures, estimates and data included in this article are as on date. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. The statements contained herein may include statements of future expectations and other forward-looking statements that are based on our current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. Readers shall be fully responsible/liable for any decision taken on the basis of this article. Investments in securities market are subject to market risks, read all relevant documents carefully. Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
Excellent
GOI yield going past 7.5 , comfort on PE has gone down
Even 20PE look high and also earning growth slowing and stagnating is another factor .
When 6.5% GOI yield, 20PE was looking ok .
Forward PE estimate 18.5 is difficult , as earning slowing down