Brokerages turn cautious on India amid concerns over pricey valuations

The divergence in performance has led to the widening of India’s valuation premium to most Asian and emerging market (EM) peers
Foreign brokerages have turned cautious on India amid concerns over pricey valuations and earnings delivery. In the past one week, at least three brokerages have recommended their clients to consider a higher exposure to other markets such as China and Indonesia, which have hugely underperformed India this year.

Japanese firm Nomura on Monday downgraded Indian equities from ‘overweight’ to ‘netural’, citing unfavourable risk-reward. Earlier, UBS, while maintaining an overweight stance, noted that India had turned “unattractive” due to “extremely expensive” valuations relative to the Asean countries. Meanwhile, Christopher Wood, global head of equity strategy at Jefferies, said its overweight position on India had come under a threat.

The change in stance has coincided with the latest round of correction in the domestic market. The benchmark indices on Monday would have posted a fifth straight day of loss if not for an 11 per cent jump in the shares of private sector lender ICICI Bank, which made a 511-point contribution to the Sensex. The 30-share index managed to end with a gain of 145 points, or 0.24 per cent, at 60,967.

The broader market indices extended losses with the Nifty Smallcap 100 index dropping 2.3 per cent and the Midcap 100 falling 1.7 per cent. Both indices are now down over 8 per cent from their recent highs, underscoring the pain in the market.

“We now see an unfavourable risk-reward given valuations, as a number of positives appear to be priced in, whilst headwinds are emerging. We, thus, downgrade India to neutral in our regional allocation and will look for better entry points given our still-constructive medium term view. We like China (significant underperformer seeing stabilising sentiment) and Asean (tactically laggard reopening play),” said Nomura equity strategists Chetan Seth and Amit Phillips in a note.

Last week, the Nifty posted its first weekly underperformance to the Asian market gauge in six weeks. Notably, the index has outperformed the MSCI Asia Pacific index in 21 out of 26 weeks since May.

“India, like Taiwan, looks very poor on our scorecard framework. The relative valuation of India to Asean, two areas with similar growth dynamics and occasional perceived macro vulnerabilities, looks too wide to justify. We note that both in India and Taiwan, retail investors have played an outside role, which, while difficult to predict in terms of reversing, creates an additional potential headwind if this demand unwinds,” UBS said in a note dated October 20.

The Indian markets have gained 30 per cent so far this year, even as the MSCI Asia Pacific ex-Japan index is flat. The divergence in performance has led to the widening of India’s valuation premium to most Asian and emerging market (EM) peers.

Wood has said “overweight on India looks vulnerable but GREED & fear would use any near-term weakness to add to what is a structural overweight”.

Currently, Jefferies runs a 230 basis points overweight on India. It recently upgraded China from neutral to overweight. In the MSCI Asia Pacific ex-Japan index, India has a weighting of 11.7 per cent, lower than other peers such as China (34.3 per cent), Taiwan (13.8 per cent), and Australia (14.6 per cent).

Nomura says most positives for India are “well known and appear priced in”. Key factors behind India’s outperformance this year have been a ramp-up in vaccinations, the reopening of the economy, and demand recovery.

The key risks facing domestic equities are policy normalisation amid sticky core inflation, elevated commodity prices, and tentative signs of a slowdown in demand, said the brokerage.

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