Indian equities remain appealing
Domestic equities saw more volatility and a sell-off from foreign investors. After rallying for over two years, the markets seem to be in the consolidation phase. Although valuations are lower, they continue to outperform other emerging markets.
The pessimism in local markets is largely focused on the implications of rising global interest rates and inflation for the Indian economy. We believe that these factors will contribute to prolonged volatility.
High equity valuations have been fuelled by the low bond yields experienced since the global financial crisis. With the US Federal Reserve and other central banks unleashing a hiking cycle this year, earnings growth will be vital to sustain valuations.
So far, many companies have reported margin pressure, in all sectors, due to climbing wage bills, raw material expenses, and oil prices. Luckily, the government is keeping the accelerator on, with spending on capital expenditure (capex) projects. As such, the hit to demand in India may not be as bad as initially thought.
Investors seem to be moving capital away from emerging market assets. However, domestic flows have helped to protect the effect of this shift on small-cap companies, whereas large caps have suffered considerable outflows, given that overseas investors have typically favoured quality and growth stocks. The recent sell-off in these stocks has borne the brunt of the market correction over this period. As the fundamentals for quality and growth companies are largely unchanged, the resulting subdued prices suggest that they offer attractive entry points.
One sector where valuations have been hit hard is information technology (IT) services, on concerns that a possible slowdown in the US may reduce IT budgets. However, with fairer valuations for the sector now and a strong earnings outlook over medium term, in our view, share prices in the sector may bounce back over the rest of 2022.
While there may be some earning downgrades in coming weeks, hints of sustainability in underlying demand and predictions of a normal monsoon season should support markets. Hence, we maintain our overweight stance on Indian equities.