On the eve of the Budget, top foreign brokerage houses Morgan Stanley and JP Morgan were advising investors to stay away from the Indian stock markets, saying the risk factors involved in Indian equities are much higher.
Morgan Stanley analysts Ridham Desai and Kuleen Tanna, in their India strategy report, point to five myths about the Indian market and conclude that "the ultimate point is what returns are embedded in stock prices rather than what multiples they are trading at.
Using a rigorous three-stage residual income model, we conclude that at the current level, the market is implying a long-term (10-year) compounded annual return of 11 per cent. To us, this seems lower than what investors deserve, based on our judgment of risk factors involved in Indian equities."
Similarly, JP Morgan strategist Adrian Mowat says it is time "to get out of India" while its head of regional banks, Sunil Garg, has a zero weighting in his regional banks portfolio for Indian banks, first time since the mid 90s.
Bharat Iyer, JP Morgan's Indian strategist, is concerned that risk to consensus earnings estimates is on the downside. JP Morgan has downgraded India to `underweight' drawing a parallel between the rising interest rates at the moment to 1994-period when prime lending rates and mortgage rates hit the roof.
The first myth relating to the Indian capital markets, according to Morgan Stanley, is Indian equity valuations are overstated because of India's unique sector composition.
"Our work shows this to be untrue. The most common misconception is that India's sectoral composition is skewed towards sectors that trade on a higher multiple (due to their non-cyclical nature). Save for technology, India's sector composition is hardly different from the average represented in the MSCI (Morgan Stanley Composite Index) Emerging Market," Desai said.
The second myth is that India's high Return On Equity justifies its premium valuations. But "the premium seems a bit too much for India's sustainable ROE. The third myth is that equities are attractive relative to bonds but that assumes that bonds are fairly valued and that earnings are not inflated. "This (equity is attractive to bonds) does not tell us if bond yields are lower than they should be, i.e., bonds are overvalued."
The fourth myth is that returns have only played catch-up with GDP growth. However, this does not explain the more than quadrupling of the market cap to GDP ratio, the Morgan Stanley analysts said.
The fifth myth is that Indian equity valuations compare favourably with history. "Absolute multiples are approaching multi-year highs but they are still not past the tech bubble peak of 2000. However, this has to be seen in the context of how equities trade elsewhere in the world.
Multiples are just off multi year lows in the rest of the world.. India trades at a premium to the rest of the world versus a discount in the past. "Part of the premium is justified by India's long-term growth prospects but nobody can really be sure of what the fair level of premium should be," the Morgan Stanley report said.
