16 MARCH 2020
Indian equities have declined 25% since their January 2020 peak, in line with global equities. Combined impact of Covid-19 global outbreak and stress in the financial sector has induced a sharp FII sell off to the tune of over USD 4bn in the last two weeks. DMFs, however, continued to provide support through February 2020 with INR 95bn of inflows.
From a valuation perspective, Nifty is currently trading at a 1yr-fwd P/E valuation of <15x, trending ~2 standard deviations (sd) below the 5yr avg. Bond Yield Gap (10yr GSec – 1yr-fwd Earnings/Price) has now declined to less than zero, also trending 2sd below its 10yr mean. Compared to other Emerging Markets, valuation premium for Indian equities is now below the long-term average.
Source: Bloomberg, Citi Research; Note: Bond Yield Gap = 10yr GSec – Fwd E/P
While equity valuations now appear attractive post the recent slide, near-term volatility cannot be ruled out.Citi analysts warn that FY21 earnings growth expectations of +24% YoY are on the higher side and expect downgrades in the coming months. They now expect global EPS to contract by 10% YoY in 2020 (vs. flat YoY earlier) following Covid-19 impact on economic activity and steep fall in crude prices.
Citi analysts revise their Nifty50 target for Dec 2020 to 11,400 (from 12,200 earlier), implying a ~19% upside from current levels. They cut the target earnings multiple to 14.5x 1yr-fwd earnings (~2sd below 5yr mean) to incorporate the elevated earnings risk.
While lower oil prices may help in the medium term, effective resolution of the financial sector stress and the trajectory of Covid-19 contagion in India will be of essence. A global recession or reversal in domestic mutual fund flows may pose further downside risks.
Subject to risk appetite, investors who are underweight equities may look at long term opportunities created by recent correction and invest in a staggered manner. Fixed Income investors may continue to prefer High credit quality with short duration and remain diversified in their portfolios. Fixed Income Investors with higher risk appetite may also look at allocating to dynamic bond funds having high credit quality portfolios.