What drives the global outperformance of Indian stocks

In the same period (January-mid-October), the DJIA (USD denominated) is down 17.5 percent, and the Frankfurt DAX is down 21.7 percent (euro-denominated) and London’s FTSE (GBP denominated) is down 7.8 percent. . Among the major emerging markets, the Shanghai Composite lost 14.9 per cent (RMB denomination).

The comparative outperformance or defensive strength of Nifty is related to several factors. One is that India is touted as the fastest growing large economy this fiscal year, even though India’s GDP estimates have also been lowered several times, and estimates are probably in the relatively larger informal sector. Do not fully reflect weakness. Economy for long-standing weaknesses, gaps and redundancies in the estimation method. Still, as things stand, the growth forecast in China, Indonesia, Brazil, South Africa and of course, Russia is very poor. Many of these economies also have challenges and weaknesses in GDP estimation.

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The rupee has fallen around 10.8 per cent against the US dollar, but has gained against the euro, yen and pound. As a result, India has seen relatively little outflow of global capital, even though FPIs have made a huge net sale. 1.77 trillion in equities since January and the RBI has spent huge sums of money to protect the rupee. Domestic institutions have found resources to absorb those FPI sales. Indeed, domestic institutions have bought the net 1.94 trillion from January, which is enough to balance the retail exit as well.

In addition to global macro considerations, there are other factors to consider. One is the K-shaped growth trend in the Indian economy. The informal economy has been hit by a series of negative events over the years – demonetisation, GST, and finally the pandemic, which led to a catastrophic decline in employment.

But the formal economy has performed fairly well during this period – in fact, one could argue that the GST has virtually formalized the economy, with large, formal sector firms taking on the market shares of smaller informal firms. is captured. Listed companies, which by definition are part of the formal economy, have also performed well in this way.

The pandemic triggered a series of cost-cutting measures and corporates enjoyed strong profit growth, even though revenue growth has not been strong. Several big concerns have successfully drained the balance sheet, retiring expensive debt. As a result, large companies have strong balance sheets and a proven ability to weather storms, and both of these characteristics make them attractive to the global investor.

But the most important basis for the outperformance of Indian stocks could be the prevailing negative real interest rates. Interest rates in real terms have been negative since September-October 2021, when inflation started rising. The RBI kept policy rates down until May 2022, when it instituted an out-of-turn hike and other measures to bolster liquidity.

However, even after three hikes, rupee interest rates are still low or negative in real terms as compared to inflation. For example, 10-year government bonds are traded at 7.4 per cent and 364-day Treasury bills are traded at 7 per cent, where CPI inflation is trading at 7.4 and wholesale price inflation is at 10.7 per cent.

Lower rates automatically favor higher valuations for riskier assets like equities. Investors value businesses based on their expectations of future profits, and compare those returns to the returns available from secured assets such as low-risk debt or risk-free government debt. The present value of (estimated) future profits is greater if the (known) return from debt is less.

This is the situation in India – interest rates are low and Nifty maintains a price-earnings multiplier of 21-plus. This valuation equation will change as and when nominal interest rates rise above inflation, as will happen if the RBI continues to rise and higher policy rates are transmitted through the financial system. Once this happens, the risk-free return will be higher.

Or, the equation will change as and when investors lower earnings expectations. We’ll have a better understanding of this once broad-scale Q2 results and management guidance are available across multiple regions. But many corporates have already spoken of a possible slowdown.

Given the deteriorating macro-environment and the central bank’s monetary stance, both of these things could happen: earnings expectations could fall and real interest rates could rise, leading to a major sell-off. But till then, India’s stock market indices may continue to outperform relatively.

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