Neutral On Indian Equities, Looking For A Favourable Entry Point

We remain bullish towards Emerging Asian equities relative to Developed Asian equities due to a superior economic growth outlook, cheaper valuations, and a more favourable technical picture. Within EM Asia, our favourite pick has long been the Shanghai Composite. We argued earlier this year that Chinese equities were very cheap even relative to Emerging Markets globally (See 'China Yet To Participate In EM Rally', May 21) and called for Shanghai Composite outperformance amid an increasingly attractive technical picture.

In EM Asia, Indian equities have been on the rise, hitting all time highs. The Sensex Index is one of the best performing markets globally since the start of 2014, returning 26.7% year-to-date (YTD) as compared to MSCI Emerging Market (EM) Index and MSCI World Index (which returned 7.2% and 4.2%, respectively YTD [in USD terms]). Even on a 10-year annualised basis, the Sensex Index outperformed both MSCI EM and MSCI World Indices, returning 14.7% (as compared to 7.5% and 4.2% for the two other indices, respectively). The outperformance of Indian equities since the start of the year can be attributed to the optimism by investors over the landmark win by the Bharatiya Janata Party (BJP) led by the new Prime Minister, Narendra Modi. Despite the improving fundamental outlook, and reasonable valuations, we hold a neutral view on the Sensex due to the deteriorating technical picture.

Reasonable Valuations

Significant Outperformance
Year-To-Date (YTD) Comparative Returns Of Sensex, MSCI EM & MSCI World Indices (Top) & 10-year Annualised Returns

We remain bullish towards Emerging Asian equities relative to Developed Asian equities due to a superior economic growth outlook, cheaper valuations, and a more favourable technical picture. Within EM Asia, our favourite pick has long been the Shanghai Composite. We argued earlier this year that Chinese equities were very cheap even relative to Emerging Markets globally (See 'China Yet To Participate In EM Rally', May 21) and called for Shanghai Composite outperformance amid an increasingly attractive technical picture.

In EM Asia, Indian equities have been on the rise, hitting all time highs. The Sensex Index is one of the best performing markets globally since the start of 2014, returning 26.7% year-to-date (YTD) as compared to MSCI Emerging Market (EM) Index and MSCI World Index (which returned 7.2% and 4.2%, respectively YTD [in USD terms]). Even on a 10-year annualised basis, the Sensex Index outperformed both MSCI EM and MSCI World Indices, returning 14.7% (as compared to 7.5% and 4.2% for the two other indices, respectively). The outperformance of Indian equities since the start of the year can be attributed to the optimism by investors over the landmark win by the Bharatiya Janata Party (BJP) led by the new Prime Minister, Narendra Modi. Despite the improving fundamental outlook, and reasonable valuations, we hold a neutral view on the Sensex due to the deteriorating technical picture.

Significant Outperformance
Year-To-Date (YTD) Comparative Returns Of Sensex, MSCI EM & MSCI World Indices (Top) & 10-year Annualised Returns
10-Year Annualised Returns
Sensex Index 14.7%
MSCI EM Index 7.5%
MSCI World Index 4.2%
Source: BMI, Bloomberg. As At August 15.

Reasonable Valuations

Fundamentally, we believe that the earnings outlook for Indian corporates will improve on the back of an improved business environment as the National Democratic Alliance (NDA) government is looking to propose further reforms in various sectors of the economy, to reaccelerate economic growth in the country (which we are forecasting real GDP growth to reach 5.6% in FY2014/15 [April-March] from 4.7% last year). In absolute terms, a 2.1x price-to-sales ratio, a 2.9x price-to-book ratio, and a cyclically-adjusted P/E ratio (CAPE, using average earnings over the past decade) of around 21.0x seem expensive. This is especially the case when compared to most other emerging markets. However, relative to its own historical averages, Indian equities look much more reasonably valued, trading well below their 10-year averages.

Not Cheap, But Below Long-Term Average
India - Price-To-Sales & Price-To-Book Ratios

Similar price-to-sales ratios in the past have resulted in 20% annualised total returns over the subsequent seven years. While we do not expect to see a repeat of this going forward, this does suggest that valuations relative to EM averages may not be such a problem.

Strong Annualised Total Returns Not Expected At These Valuations
India - Price-To-Sales Ratio (LHS) & 7 -Year Subsequent Annualised Returns, %

Technical Signals Pointing To Potential Correction

Furthermore, several technical signals are pointing to a potential correction in Indian equities. Firstly, breadth measures such as the number of stocks hitting new 52-week highs are showing significant divergence with price. Indeed, the Sensex Index hit a new all-time high again on August 18, but the number of new 52-week highs has been decreasing since May.

Participation Decreasing
Sensex Index Versus Stocks Hitting New 52-week Highs

Secondly, looking at momentum measures, the RSI is showing a decline in momentum while the price is increasing on the weekly chart, suggesting that there is an increasing potential for a correction in the Sensex Index in the coming months.

RSI Showing Divergence
Sensex Index And Relative Strength Index

Looking For A Favourable Entry Level

We believe that a correction in equity prices will provide a more attractive entry level for Indian equities. We are looking at a retracement of least 10% to 23,000 from the current all time highs of around 26,000 before considering a bullish view on the Indian market.

ASIA ASSET CLASS STRATEGY
  ENTRY DATE ENTRY LEVEL % GAIN/ LOSS RATIONALE
         
FOREX
BEARISH CNY 12-MONTH NON-DELIVERABLE FORWARD 27-Jan-14 6.1150 1.7% Excessive strength versus trading partners, domestic economic weakness, and banking sector instability to lead PBoC to weaken currency
BEARISH NZD VERSUS USD 29-Apr-14 0.8530 1.6% Extreme valuations, excessive bullishness towards the currency, and a precarious housing market outlook points to a bearish fundamental outlook for the currency
BULLISH ASIA BASKET VERSUS DM BASKET* 27-May-14 1.76 0.3% Asian FX is trading at all-time lows versus our basket of DM currencies, despite the fundamental forces (real rates, current accounts, growth outlooks) being heavily in favour of Asian FX outperformance
         
FIXED INCOME
BEARISH JAPAN 10-YEAR BOND 6-Mar-13 0.64 -13 bps A bubble increasingly at risk of bursting as a result of BoJ policies
BULLISH INDONESIAN 2023 BOND IN US DOLLAR TERMS 1-Jul-14 10.20 1.0% The high yield and oversold currency offers protection from an adverse election result, while leaving large potential for upside in the event of a favourable result
         
EQUITY INDICES
BEARISH AS51BANKS VERSUS AS51 INDEX 4-Feb-14 1.6 0.8% Banking system at risk from domestic property weakness and hot money outflows.
BULLISH SHANGHAI COMPOSITE VERSUS AUSTRALIA AS51 28-May-14 0.3709 7.2% Chinese equities look technically bullish and are cheap, while the opposite holds true for Australian equities.
BULLISH MSCI ASIA EX-JAPAN VERSUS ASIA DM BASKET** 23-Jul-14 1.245 1.7% Relative economic growth outperformance, cheaper valuations, and a much more bullish technical picture all suggest that the MSCI Asia Ex-Japan index outperformance.
SECTOR STRATEGY        
BULLISH THAILAND LIVESTOCK 12-Aug-14 29.25 2.6% Positive outlook for Thailand's poultry sector,based on demand dynamics and low grain prices boosting margins.
Source: BMI, Bloomberg. *An equal-weighted basket of INR, IDR, KRW, SGD, PHP, MYR, and TWD versus an equal-weighted basket of EUR, NZD, AUD, CAD, CHF, and GBP. **An equal-weighted basket of Australian AS51, New Zealand NZSE, and Japanese Nikkei. As Of August 20, 2014

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Related sectors of this article: Economy, Finance, Equities, Economic Activity
Geography: Asia, India
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