The Indian market now trades at a five-year trailing average multiple which is at a near 50% premium to the emerging markets. And emerging markets stocks themselves are trading at the highest valuations, in two years, relative to shares in the developed world. Despite the Indian market becoming so expensive, foreign investors clearly love it; $13 billion has poured in since the start of 2010, which is some kind of a record. India has outperformed emerging markets since February, when sovereign risks had just surfaced as had anxiety about a delayed recovery in the western economies. But the promise of growth has continued to lure investors to India. After giving a bit of a scare, the government now confirms that demand is robust, growing at a remarkable 10% year-on-year and not at an anaemic 3.7%. Private consumption in the three months to June 2010, grew at 3.8% while government expenditure was up 14.2% and investments clocked 7.6%.
Also, although the India August HSBC Manufacturing PMI moved down a notch to 57.2 from 57.6 in July, manufacturing output and new orders continued to expand. What?s more! Goldman Sachs points out that inflationary pressures may be easing given the lower Output Price Index and the Input Price Index remaining lower than at the start of the year. There are some trouble spots?demand for cement isn?t as strong as it could be and prices of steel and lead are going up though cars and CVs don?t seem to be short of takers. But earnings growth is clearly tapering off?the June 2010 quarter numbers were clearly below expectations prompting more downgrades than upgrades. For a sample of 2,103 companies, net sales were up a fairly good 22% year-on-year, but operating margins (OPM) came off by a sharp 300 basis points to 17.8% while the net profit grew just 7.5% year-on-year. It?s clearly possible that analysts are overestimating earnings especially since a third of the Sensex earnings is driven by commodity and energy stocks. So, while an 8%-plus GDP this year appears wonderful, companies may not turn in the kind of numbers that are being pencilled in. In addition, forecasts for global growth, for the second half of the year, have been lowered to 2.3%, with the spectre of deflation looming large. Moreover, with bond yields already at historic lows and credit demand weak, even if the US Fed buys another $500-1 trillion of US treasuries, it may not really stimulate the economy, according to JP Morgan, which says the risk is thus rising that the mature economies of Europe and North America are joining Japan into a decade of low growth and deflation. JP Morgan believes that equity investors worried about deflation risk should favour emerging markets over developed markets. Indeed, there is a school of thought which says that although in the past, emerging markets may have underperformed the developed pack after trading at a premium, this time around it could be different. That?s because these nations are now less indebted, their companies are more profitable and growth is twice as much as it is in the advanced economies. HSBC believes there?s a case for a re-rating of emerging markets because the fundamentals have changed. For sure, India is in a sweet spot but will stay there only if companies deliver.