Indian equity market most expensive after China

FOLLOWING the 2,000-point (14%) correction in the Sensex, the P/E has fallen 18 times the one-year forward earnings. While that may provide some relief to investors, it has reinforced the fact that the Indian equity market is the most expensive emerging market after China.

Even after a 10%-plus correction, the Chinese benchmark index - Shanghai Composite - is currently trading at some 34 times the one-year forward earnings. After the recent bullishness among its industries, Japan’s benchmark index - Nikkei 225 - is trading at 22 times the one-year forward earnings. Little wonder then that money has been flowing out of these markets.

According to EPFR.com data, outflows from India and other emerging markets so far are nearly 50% of their investments into
them. This is significant considering that valuations in India still look stretched in the wake of global weakness and the impact of the Union Budget that is expected to slow down growth for India Inc. “What is not surprising is the fact that profit-booking is expected once markets have reached their potential. But what is surprising is the lack of depth in the emerging markets, including India. A 10% sell-off leads to panic sales,” says an investment manager of a UK-based hedge fund, currently operating out of Mauritius, with a $100 million-plus India fund.

The depth of the Indian market has been questioned by many FIIs. Even though the Indian equity market has seen a correction in line with other emerging markets, the spiralling effect is scary. Part of the reason is because small investors, who are more like speculators, invest directly into the equity market.

The Indian benchmark index is currently trading at 18 times the one-year forward earnings. And the general consensus among FIIs and hedge funds is the index will continue to give a 200-300 basis points (2-3%) premium for the India growth story. A 10-year study shows that the benchmark index trades at 14.5 times the one-year forward earnings. Accommodating the 2-3% premium, it looks like valuations are getting back to normal.

But things seem to be changing fast considering that the risk appetite for emerging equities has declined. “Even from these levels, there is more possibility of a downside than an upside,” says one of the top three FIIs with a large investment portfolio in India and other emerging markets.

Yet taking a contrarian view, there are some who believe a further correction would be the right time to buy the ‘India story’. A Morgan Stanley analyst, based out of New York, states: “My view remains the same as reported in our research note. This is an extended bull market, and a correction is long overdue. So, we would buy after a 10-12% correction in the Indian equity market.”