Indian equities have outperformed the MSCI World index by 22% in the past one year, the most in seven years, show data from Bloomberg. They also outpaced the emerging market counterparts (MSCI EM index) by 36%.
A large part of the gain in the current calendar year has been driven by domestic money – Indian equities received just $1.5 billion of foreign inflows in the last six months despite foreign investors reducing their exposure to China.
Local equities delivered a return of about 12% in the third quarter of 2021 so far, one of the best among large markets. They have also not seen any correction of over 10% in the past 260 days, which is the third-longest rally ever after 2013 and then in 2016.
Historical data suggest that if Indian equities reach such a high level of outperformance, then the returns become muted for the next few months. According to Jefferies, a high degree of outperformance is usually followed by India underperforming by 11%, 6% and 7% on average in the following 90, 180 and 365 days, respectively.
The absolute and relative valuations of Indian equities are hovering at a record levels. The Nifty50 is trading at 22.3 times the one-year forward earnings, a 41% premium to its long-term average.
A comparison of PE of the top global equity indices shows Nifty’s valuation as the most stretched by a margin at nearly the 100th percentile of the 16-year trading range, show data compiled by CLSA. No other market is within 5% of the record valuation in terms of the percentile trading range.
On relative valuation, the price-earnings premium of India has reached a record level against Asian counterparts, while the premium with EM peers is at a more than 15-year high. The gap between the bond yield and earnings yield – an inverse of price-earnings – is 1.65, compared with the average of 0.97. A reading of a yield spread of more than 1.65 has historically resulted in negative returns in the following 12 months.