The Nifty50 index has risen close to 30 per cent in the year so far, bettering returns of the US, the UK, European and many Asian stock markets.
As the New Year approaches, the tide is turning against the Indian market as reflected in a downgrade in stance by some major global broking firms such as Morgan Stanley, UBS Securities, Goldman Sachs, Nomura India and Credit Suisse.
“After gaining nearly 31 per cent YTD and 44 per cent since our upgrade in November last year, and being the best-performing regional market in 2021, we believe the risk-reward for Indian equities is less favorable at current levels,” brokerage firm Goldman Sachs had said in a note last week.
That said, there are four reasons why Indian equities could fare worse than other major markets in the New Year.
Much of the rally in the benchmark stock indices in India have been driven by a swift factoring in of best-case scenario earnings and economic growth over the next two years. The Nifty50 index is trading at 22 times one-year forward earnings, which is well above its historical average. The market cap-to-GDP ratio is above 125 per cent, well above the long-term average of 77 per cent. “We expect a structural multi-year earnings recovery, but at 24x forward P/E, we look for some consolidation ahead of Fed tapering, an RBI hike in February and higher energy costs,” said brokerage firm Morgan Stanley in a recent note.
Muted FPI money, possible slowdown in retail flows
The downgrade instance from a clutch of international broking houses as well as the expensive valuations in the Indian market have already made foreign investors look elsewhere for better risk-reward. With emerging market basket taking a hit, thanks to the slowdown in China and investors withdrawing money from EM ETFs, inflows to Indian equities may remain muted till valuations become more attractive. In the absence of a thrust from FPIs, retail investors took up the mantle in 2021. Retail investors have invested over Rs 80,000 crore in local equities in 2021. But with offices reopening amid high vaccination rate, there is concern among some market participants that the magnitude of retail inflows will not be sustainable.
Earnings upgrade cycle slows
Besides the rerating in valuations seen over the past 12 months, thanks to negative real interest rates in India and abroad, the hefty upgrades in corporate earnings since the September quarter of last financial year have also played their part in India’s bull market so far. The September quarter earnings season threw more negative surprises than positive ones, with brokerage firm Motilal Oswal Financial Services suggesting that the upgrade-to-downgrade ratio was largely neutral. While pent-up consumer demand should help sustain top line growth over the next two quarters, soaring input costs as well as high base effect could further slowdown earnings growth momentum in 2022.
Strengthening US dollar
In recent weeks, the US dollar has shown signs of life as the US Dollar index has blown past the 95 mark and is sitting close to a more than 16-month high. Typically, a strengthening dollar is bad news for the global emerging market basket, and combined with sky-high valuations of the pack over the past year, it becomes a recipe for underperformance. Investment bank Credit Suisse recently downgraded EM equities to “market-weight” due to deterioration in risk reward, a strengthening US dollar and only minor easing of policy in China to battle a slowdown.
Over the past two years, Indian equities have exhibited an inverse relation with the US Dollar index and any strength in the greenback is likely to further accelerate withdrawal of funds by foreign investors.