In a recent report, foreign brokerage firm CLSA has expressed caution regarding the current valuation levels in the Indian stock market, describing it as not only stretched but also the most expensive large market globally.
Despite remaining bullish on certain stocks, including Reliance Industries, HDFC Bank, ICICI bank, Infosys, L&T, Axis Bank, Sun Pharma, Oil & Natural Gas, SBI Life Insurance, IndusInd bank, Hindalco, and ICICI Prudential life, CLSA warns that the elevated starting point may impact returns in 2024.
The report notes that Indian equities began the year with extreme bullish sentiment, boasting top-decile valuations and a record discount to debt yields. The Nifty’s Price-to-Earnings (P/E) ratio stands at 20.2x, a level witnessed on only 8% of days over the past 18 years.
The market’s valuation premium to its historical average is the highest among the 19 largest global markets. However, it is no longer the leader in earnings-per-share (EPS) growth, raising concerns for potential reversals.
CLSA emphasizes that India has become the most expensive among the world’s largest markets, trading in the top decile of its historical range. This puts the country at risk of correction in case of narrative or earnings growth disappointments.
The report highlights the possibility of a rotation of investment flows away from India if other large but attractively priced emerging markets show improvement in their investment narratives.
Furthermore, the Nifty earnings yield discount to the Indian 10-year government security yield is at 2.2 percentage points, a level observed on only 3% of days since 2005. This position historically resulted in negligible one- and two-year returns. CLSA warns that any significant growth slowdown or delays in inflation cooling pose risks for equities.
In the context of a consensus soft landing scenario in the US, CLSA predicts a migration away from equities into bonds. This shift could be driven by equity valuations at a premium to bonds in both the US and India. The report suggests that a larger share of foreign institutional inflows (FII) in this scenario will come from non-India dedicated funds, potentially supporting mega-caps over small-/mid-caps.
CLSA recommends selectivity in the small-cap and mid-cap space, favoring megacaps, banks, insurance, and energy. The brokerage expects banks, L&T, Bharti Airtel, and select material names to make an outsized contribution to the Nifty’s EPS growth, emphasizing the importance of delivering on these expectations.