This appeared in the paper on 13 December 2021 (link).
Equity risk premium of Indian markets is still near historic lows, indicating that the strong medium-term prospects for Indian economy are more than priced in, said Neelkanth Mishra, co-head of Asia-Pacific strategy and India equity strategist at Credit Suisse. In an interview, Mishra said policymakers may not be in a position to support growth, given the fears of heightening inflation. Edited excerpts:
How would you summarize Indian equity markets’ performance in 2021 amid a brutal second wave, earnings recovery and the liquidity strain at the end of the year?
The second wave of covid-19 caused more infections and deaths than the first, but was short-lived, and with the healthcare system better geared up than last year, lockdowns were less intense too. Not only did this mean less economic loss, it also meant less uncertainty for markets. During the year, financial results of listed companies also turned out to be better than feared, driving significant upgrades to earnings estimates for FY23—a rare occurrence, given that over the past decade, earnings estimates have tended to get revised down. Due to this optimism and strong inflows from domestic savers into equity markets, by the middle of the year, price-to-earnings multiples for the market had risen to very high levels, and the premium to global markets had also reached decadal highs. As the pace of earnings upgrades slowed, high energy costs became headwinds to India’s economic recovery, and expectations of a taper hurt other emerging markets, driving foreign investor outflows from India too.
If policy normalization starts to kick in, will it impact private capex and overall earnings?
It is time to bring back the car-driving parallels—stepping off the accelerator is different from applying brakes. If monetary policy normalization is in response to stronger-than-expected growth, it should not affect capex and earnings. The monetary policy committee (MPC) has pegged its September 2022 quarter inflation estimate at 5%, and growth at 8%. We believe the latter can be higher than MPC’s forecast, and so, have been strong advocates of removal of policy accommodation. The RBI has already embarked on it, by raising the variable rate reverse repo by nearly 60 basis points since September, in the process triggering deposit rate hikes by banks and pushing the yields on the 10-year government bonds to pre-covid levels. The reason why it has chosen to not raise reverse repo rates is perhaps uncertainty around the Omicron spread, and on global growth. As India’s growth indicators stabilize, it can embark on normalization with a surer hand. We do not expect it to affect the recovery.
Why do you think equity risk premium of India is at a record low?
It is at a record low when the risk-free rate used is the Indian government bond yield. Part of the reason for this is that Indian bond markets have priced in monetary policy normalization very early, with the gap between the RBI-set repo rate and the bond yield at 235 basis points—record highs. This makes the 10-year bond yield quite attractive vs equities. At the same time, corporate earnings are emerging from a nearly decade-long earnings lull, and markets are confident of strong prospects for equities. If one uses the US treasury yield, it is not at a record low, but not far. This is one of the reasons we turned cautious on the market in September, and while the correction since then has moderated P/E ratios, we expect some time correction for the headline indices going forward too. Within the market, there are several sectors and stocks which are not as expensive, which can give good returns.
Do you think inflation is a bigger risk to Indian equities than covid?
Global inflation, and in particular US inflation, is definitely something that can be a risk, if nothing else because of uncertainty. US inflation is at levels not seen for many decades, and very few of current market participants have the experience of operating in such markets. Given that the US treasury yield has been the anchor for valuation of most assets globally, and if they rise rapidly, they can destabilize several market assumptions that have not been tested for a decade. That said, CS Global strategists believe till a 3% level, equities don’t get negatively impacted.
Unlike other global brokerages, are you worried about India’s steep valuations?
While we are much more constructive than consensus on India’s economy in FY23 and beyond, we have been concerned about valuations since September. Even if the Nifty remains unchanged for a year, and earnings estimates remain unchanged, the roll-forward impact on one-year forward earnings will only bring the P/E multiple to 18—the level at which Nifty had traded for four years pre-covid. However, we do expect upgrades to FY24 earnings—a year later that is what the market will be trading on, which should give some room for upside for the headline indices.
What are the big challenges for Indian markets in 2022, besides covid and inflation?
Signals on end-demand growth globally have been distorted by supply-chain disruptions and bull-whip effects for major inputs like steel. Our work suggests that end-demand, both consumption and investment outside the US is weaker than what some of the supply-constraints indicate, and this would become clearer once supply has responded to the price signals. At such a time, policymakers may not be in a position to support growth, given the fears of stoking further and sticky inflation. We believe the markets are not pricing in this scenario, and when these growth fears emerge, global markets may be choppy, with some of those concerns showing up in India too.