Global brokerage firm CLSA has stepped up its India allocation to '20 percent overweight' from '40 percent underweight', hoping that the country's strong economic fundamentals will help sustain the momentum in equity market.
CLSA cites eight factors supporting the '20 percent overweight' position in India, including strong credit impulse, favourable energy prices, improving external balances, robust GDP growth, incremental EPS, increased profitability, a positive macro outlook, and rise in foreign asset accumulation. However, concerns have been raised about valuations and the monetary policy inflexibility of the Reserve Bank of India (RBI).
The brokerage house expects India's credit impulse to support equities, with the Nifty 50 momentum in the 20-35 percent range. Favourable energy pricing and potential global fixed-income benchmark inclusion could help bridge the balance of payments gap and lead to rupee appreciation.
India's GDP growth outlook surpasses that of emerging markets.
Indian equities: fair value with 22 percent upside
CLSA's regression model for MSCI India, based on factors like industrial production, US manufacturing data, money supply growth, and exchange rates, historically explains about 80% of monthly index movements. The model now suggests Indian equities are fairly valued, showing a 22% US dollar upside through October 2024. This outlook outperforms CLSA's expectations for the overall MSCI EM index.
India's profits outpace emerging markets again
CLSA sees India's margin compression nearing the late cycle phase as the price spread between input and output (PPI or WPI less CPI) moves from a record high in May 2022 towards the lower bound of a two-decade range by July 2023. This improvement is expected to boost India's corporate profitability, with ROE projected to rise significantly from being only 0.8ppt stronger than emerging markets in 1Q23 to 3.9ppt higher by 1Q24.
The current 129 percent price book premium for India compared to EM peers is becoming more acceptable, although consensus projections suggest it may slightly erode to 110% by the end of 2025. This premium reflects expectations for structurally superior growth and lower cost of equity, which may be warranted.
The rising relative ROE has the potential to extend India's positive value creation differential above that of overall emerging markets, typically associated with Indian equity market outperformance. Key sectors driving this improvement are IT, consumer staples, and, to a lesser extent, materials, according to consensus forecasts.
EPS growth breakout: Backed by GDP and revisions
CLSA said the consensus outlook for Indian earnings growth looks very optimistic for FY24 and FY25, exceeding analysts' initial forecasts, which historically have been overly optimistic. However, there are positive indicators for this growth, including supportive GDP trends and recent improvements in earnings revisions. This is a departure from the past decade's stagnant growth. Positive earnings revisions are particularly notable in consumer, energy, and materials sectors, but negative revisions persist for Indian IT companies.
Foreign investors maintain balanced exposure to Indian equities
CLSA said non-resident Indian equity ownership at 17.5% is below the 2021 peak of 20.6 percent, and foreign net purchases in Indian equities continue their post-2015 trend. This suggests that international investors can still accumulate Indian assets. Additionally, domestic mutual funds have seen increased three-month cumulative net inflows of 0.23 percent of market capitalization, driven by the typical behavior of Indian retail equity investors who follow equity momentum with a six-month lag, despite India's earnings yield to bond yield ratio not favoring equities in comparison to other emerging markets.
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