Sharp Sell-Off In The Indian Equity Markets - What Lies Ahead

| About: WisdomTree India (EPI)

Summary

The Indian equity markets have corrected sharply, along with other emerging markets.

Current valuations are 35% cheaper than those when Sensex hit 21,000 for the first time in Jan 2008.

India's robust fundamentals are expected to drive earnings growth and superior stock market returns over the next 4 to 5 years.

The Indian equity markets (NYSEARCA: EPI, NASDAQ: INDY, OTCPK: OTCPK:ISXIF, NYSEARCA: PIN, INDA) have sharply corrected with the Nifty fallen below 7,000 points, after touching all-time high around a year ago. The midcaps and smallcaps that have been outperforming the largecaps over quite a long time have started correcting.

The sharp correction, I believe is mainly due to the following reasons.

  • Chinese Slowdown: The slowdown in the Chinese economy, combined with fears of a further devaluation of the Chinese Yuan has triggered panic selling across emerging markets, including India.
  • Slumping Oil Prices: The oil prices have fallen sharply to below $30 per barrel. This has forced exit from global markets by the oil producing nations.
  • US Fed Rate Hike: The US Fed has said that it is unlikely to reverse its rate-hike plan during the course of this year, amidst uncertainty over the China and various parts of the world.
  • Pending Bills in the Parliament: The Parliament is yet to pass the key bills that have been pending. Especially, the much anticipated Goods & Services Tax Bill is pending.
  • Increase in Bank Non Performing Assets (NPAs): We have seen a sharp increase in NPAs and provisions for bad loans by banks. The RBI governor has asked the banks to clean-up their balance sheets by March 2017.
  • Weak Corporate Earnings: The corporate earnings have been weak, as visible from the Q3 earnings reported by Indian companies.

Market Valuations

Now that the markets are back to the levels previously witnessed 21 months ago, let us look at some interesting data points.

The chart below plots the Nifty data along with its Price to Earnings (P/E) since the first time it had peaked on 8th January 2008.

Click to enlarge

Data Source: NSE website

While a lot has happened during the last seven years, we can clearly see two things.

  1. There was a huge gap between the P/E and the Nifty, with the P/Es going as high as 29x during the initial 3 years of the period.
  2. Now, though the markets have risen above the Jan 2008 peak, the gap between P/E and the Nifty has reversed.

As we can clearly see, when the markets (Sensex) touched 21,000 for the first time in Jan 2008, the Nifty P/E also peaked to over 28x. However, if you look at the P/E during January 2015 when the markets touched all-time high levels, the P/E was around 22x, which is around 20% cheaper than the Jan 2008 valuations. Now with the latest correction, the Nifty P/E stands at 18.x. This means that in terms of valuations, the markets are around 35% cheaper than the Jan 2008 peak.

What Lies Ahead

Having said this, I would also like to highlight certain key positive factors that the markets would be closely tracking over the next 12 to 24 months.

  • Union Budget 2016-17: The Union Budget, that is expected to be announced on 29th February 2016 would be closely watched by the markets for announcements on infrastructure spending and other key initiatives.
  • Earnings Recovery: While a V-shaped recovery is not expected, I believe that earnings recovery would begin from the second half of 2016.
  • Benign Inflation: The inflation has fallen sharply over the past year and half and is in the comfort zone of the RBI, though it has risen marginally during the last 3-4 months.
  • Lower Interest Rates: With the RBI cutting the interest rates by 125 basis points last year, it has mentioned in the monetary policy statement that it would remain accommodative and further rate decisions would depend on further data pertaining to inflation and growth.
  • Infrastructure Spending: The government has been increasing spending in various infrastructure projects in areas of railways, highways and is in pursuit of developing smart cities.
  • Make in India & Skill Development: The Make in India campaign, combined with the government's programs to develop skills is expected to have a huge positive impact on manufacturing.

What to Do Now?

On this backdrop, I believe that it is a good opportunity to enter the Indian equity markets at current levels.

WisdomTree India Earnings Fund

The fund seeks to track the investment results of profitable companies in the Indian equity markets. It helps an investor gain exposure to a range of Indian companies (incorporated and listed in India) across market capitalisation, with a valuation centric approach.

EPI Chart

EPI data by YCharts

The fund manages over $1.21 bn and has a track record of around 8 years. The portfolio is spread across ten sectors with investments in around 240 companies, thus providing sufficient exposure to a wide range of Indian companies.

The fund has exposure in sectors that are expected to benefit when the economic recovery picks up. The portfolio has highest weighting to Financials (22.91%), followed by Information Technology (19.70%)and Energy (18.62%).

Looking at the valuations and considering the robust fundamentals of India, it definitely makes sense to build up positions in India-focused ETFs like WisdomTree India Earnings Fund ,with a holding tenure of 4 to 5 years.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Past performance does not guarantee future performance. The views expressed in this article are my independent views.

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