India’s forward valuations second-most expensive in the world; focus on consumption: JM Financial

The Bulls have pushed the Indian markets to unchartered territory with an upside of about 30 per cent seen so far in the year 2021. The Nifty50 surpassed 18600 levels for the first time in October, while the S&P BSE Sensex climbed above 62000.

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The Indian markets have been resilient to bad global news as much of the rally was on the back of domestic flows, JM Financial said in a note. The brokerage firm is of the view that flows are likely to remain modest from foreign investors and the current P/E ratio of the Nifty might cool down to 24-25X, which translates into a level of 16500-18500.  

Rising crude oil prices are good for the Indian markets as long as it does not cause stagflation. JM Financial sees crude oil rising towards $100 a barrel, US Fed tapering to weaken the rupee in the near term.  

All the above factors could act as a headwind for the Indian markets. Benchmark indices have already rallied by about 30 per cent so far in the year 2021.

“Higher crude prices generally have a positive impact on valuations for the Indian equities. However, this holds good as long as it is not stagflation. A disproportionate surge to say USD 100/bbl and higher risk-free rate are potential inflection factors,” said the JM Financial note.

The risk to valuation is high now both on historical and global comparisons. a) Nifty price/book at 4.3x trailing is 20% higher than 2010-19 average; CY21 P/B at 3.6x is 24% higher than the past-5-year average.

“Forward valuations for the Indian benchmarks are 70% higher than the average of 23 major global indices and are second richest after the US. The relative valuation of small/large caps has declined somewhat from July 2021 peaks of 83% to 80% currently, but is still rather high compared with the trend level of 65%,” added the note.

India’s rich valuations driven by domestic flow dominance:

Historically, there is a strong correlation between retail (and domestic) investments and valuations since the demonetization days (2016). The contribution of the retail segment to market turnover increased from 39 per cent to 65 per cent at the peak.

“This is explained by surplus banking sector liquidity emanating from an overly accommodative RBI, aggressive un-sterilised FX build, and low credit growth. Thus, the RBI’s LAF balance currently stands high at INR 7 trillion or 4.6% of bank deposits versus the desirable level of 0.5%,” said the note.

“The expected decline in RBI’s Forex reserve in response to US tapering, lower FII flows and widening CAD, RBI’s policy normalisation (stoppage of GSAP purchases) and pick in domestic credit growth would collectively narrow surplus domestic liquidity in coming months, thereby leading to a valuation correction,” the note added.

Crude oil prices can rise to USD 100/bbl, currently at USD 83/84/bbl, and FII flows will continue to remain modest. “Nifty trailing PE settling seen settling at 24-25x (currently at 27x). Benchmark multiples may moderate: Nifty target at 16,500-18,500,” the note highlighted.

Portfolio Strategy:

JM Financial remains overweight on consumption. After the recent rally seen in the IT space, it has lowered its overweight stance in IT, and maintain and equal weight in banking.

Broadly maintain OW on consumption themes

a) OW Autos: Still elevated cost (RM, components), improvement in volume, easing of semiconductor availability in 2H FY22. Added MSS, removed AL

b) Maintain OW on FMCG (removed HUL, Added Marico).

c) Lower OW on IT-strong revenue traction; margins can still surprise positively.

d) Recovery in urban real estate - Macrotech Developers (Lodha Developers).

e) Maintain EW on Banking - Increased weight for Axis Bank. Maintain UW on NBFC (added Cholamandalam Finance, reduce HDFC)

f) Consumer durables: Added V-Guard, retained Crompton Consumers

g) Oil & Gas: Added ONGC, removed IGL

h) Chemicals: Removed UPL, added PI industries.

(Disclaimer: The views/suggestions/advice expressed here in this article are solely by investment experts. Zee Business suggests its readers to consult with their investment advisers before making any financial decision.)