Is the Bullish Case for Indian Markets Still Intact? A Deep Dive into Valuation, Earnings, and Growth
In recent years, India has emerged as one of the most resilient and fastest-growing markets globally. Yet, amid recent earnings declines, valuation concerns, and tax policy changes, investors are questioning whether the bullish case for Indian equities remains as compelling as before. Let's explore the factors that are driving—or challenging—the Indian market's trajectory.
1. Valuations: Are Indian Markets Expensive?A common critique of Indian equities is their elevated valuations compared to global peers. Here’s a look at PE ratios across major global indices:
While India does appear to have a premium valuation, it’s essential to consider the growth outlook and earnings potential. India’s projected GDP growth rate is around 7%, among the highest in the world, while inflation remains moderate at ~5%. This mix of high growth and moderate inflation supports a higher PE multiple, as companies can potentially deliver earnings growth in the 16-17% range with just a modest outperformance.However, this premium must be approached with caution, especially as earnings growth shows signs of moderation.
2. Earnings Growth: A Troubling Downtrend?
For the first time since the onset of COVID-19, companies in the Nifty 50 have reported two consecutive quarters of earnings decline. Here’s a snapshot of recent earnings for the Nifty 50 (in ₹ Crores):
- Q4 FY22: ₹ 2,23,491
- Q1 FY23: ₹ 2,01,609
- Q2 FY23 (Estimated with 34 Companies Reporting): ₹ 1,93,373
This two-quarter decline highlights potential vulnerabilities within headline Indian indices. Some factors contributing to this decline include rising input costs, tightening financial conditions, and a possible moderation in demand. In an environment where valuations are elevated, any ongoing weakness in earnings growth could put downward pressure on prices.
3. Tax Rate Hikes:
Higher Capital Gains Tax and Its ImpactRecent tax policy changes have further complicated the outlook for Indian equities. Capital gains tax rates have been pushed higher by nearly 25%, impacting the required rate of return (RRR) for investors. Higher taxes on capital gains mean that investors now require a higher rate of return to achieve the same after-tax gains, adding to the cost of equity investments.This tax hike not only affects short-term traders but also long-term investors, as it raises the hurdle rate for equity returns. As a result, Indian equities need to deliver higher growth just to remain competitive with alternative investments, particularly in a high-yield environment.
4. The Global Context: Liquidity, Rates, and Capital Flows
The U.S. Federal Reserve's interest rate policy plays a significant role in shaping the investment landscape for emerging markets. With the Fed expected to continue easing rates, a global liquidity rush could benefit Indian equities as capital seeks higher-growth regions. Foreign Institutional Investors (FIIs), however, have been net sellers in Indian equities over the last 4-5 weeks, with outflows nearing $12 billion. This selling pressure reflects investor caution as bond yields have risen globally, making fixed-income investments more attractive relative to equities.
- U.S. 10-year bond yield: ~4.5%
- Indian 10-year bond yield: ~7%
These bond yields create a challenging backdrop, as equity risk premiums narrow and investors weigh the opportunity cost of equities against more attractive fixed-income returns.5. Balancing Earnings Yield and Bond YieldsOne metric often used to gauge equity attractiveness is the earnings yield (inverse of the PE ratio) compared to bond yields. Currently, the Nifty 50’s earnings yield is around 4.28%, while Indian bond yields sit at 7%. This differential suggests that equities may appear less attractive relative to bonds, especially if earnings growth falters. However, if corporate earnings can reaccelerate, Indian equities could regain favor despite the appeal of fixed-income options.
6. Growth Potential: Why India Still Shines
Despite the recent challenges, India remains one of the most attractive investment destinations due to its robust growth fundamentals. The combination of rapid urbanization, a growing middle class, and government initiatives supporting industrial growth and digital transformation contribute to a compelling long-term outlook. Even with slight moderation, India's growth rate of ~7% outpaces nearly all major economies, and corporate earnings are expected to rebound as macro pressures stabilize.
7. Risks to WatchWhile the long-term fundamentals are strong, there are risks to consider:
- Emerging Markets Basket Rebalancing in Favor of China: Recently, there’s been a trend of fund allocations shifting more toward China as it reopens and stabilizes. This could impact India’s share in emerging market funds.
- Political Uncertainty: As India heads into election cycles, political changes could influence economic policies and investor sentiment.
- Global Recession Concerns: If global growth slows significantly, demand for exports and FDI flows into India could be affected.
Conclusion: Is the Bullish Case Still Justified? India's market premium is backed by high growth expectations, but recent earnings declines, tax rate hikes, and valuation concerns should prompt investors to adopt a more selective approach. While the long-term case for India remains strong, especially compared to many developed markets, short-term caution is warranted.
Investors may benefit from focusing on sectors or companies that demonstrate resilience in earnings growth, are well-positioned to weather inflationary pressures, or have strong export profiles that could benefit from global recovery. In summary, the bullish case for Indian markets is still intact but may face near-term challenges. As always, a balanced, long-term approach with a focus on quality is key to navigating both the opportunities and risks in the current landscape.