Equity strategy: premium valuation is a major concern for REITs

We physically met around 50 fund companies in Singapore and Europe. India’s positioning has fallen to a neutral/light OWT level; implying a 50 to 100 bps weight reduction on India over the last 3 to 6 months. Premium valuation still remains the main discomfort with rising oil, although there is buy-in to India’s structural growth story. Real estate, automotive and banking were the most discussed. Some additional interest in staples also due to rising food inflation.

Indian positioning lightened but not in a hurry to add: Since October, REITs (Foreign Portfolio Investors) have largely reduced India weightings by 50 to 100 basis points, as evidenced by outflows of $19 billion. The outflow was mainly due to valuation issues. Most investors were surprised by the resilience of the market despite oil concerns and worries about India’s twin deficits. India Nifty outperformed the OPF EM/AxJ index by 6/7 ppts CYTD, despite these macro concerns and strong outperformance during CY21. Some UWT investors seemed in no rush to add India as they continue to prefer Latam and, gradually, ASEAN.

Four other top investor concerns: 1) While expected earnings declines are on investors’ minds, we note that the same is broadly visible across six sectors (autos, commodities, durable goods, cement, pharmaceuticals and industrials) which account for around 35% of market weight. Overall, we still expect Nifty’s FY23 earnings growth to be around 15%. 2) Many investors continue to fear that with rising interest rates and the recovery of the real estate market, the flow of retail investors to the stock markets will diminish. 3) The impending IPO of LIC will likely drain some of the liquidity from the stock markets. 4) Weak demand trend from rural India will weigh on broader economic growth. We believe that the expected recovery in construction activities will likely improve remittances which, in turn, will improve rural demand.

Our point of view: At 19.3x, Nifty is trading at a 16% premium to the 10-year average and around a 70% premium to the EM benchmark, around 30 ppt above from the average. Additionally, with the 10-year yield having increased by 24 basis points since the last policy, the yield spread has increased to 196 basis points, which is in an uncomfortable zone, implying an unfavorable risk reward . Our December 22 Nifty target at 17,500 implies a sideways move due to valuation concerns.

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