Indian stock market valuation premium over China, EMs narrows after recent correction

The past six months have showcased a stark divergence in the stock market performance of emerging markets (EM), with China leading the pack with a strong 26.4% gain. In contrast, several other markets, including India, Brazil, Malaysia, and Indonesia, have faced corrections, underscoring the complex market dynamics at play.

While India’s stock market has seen a valuation correction, it continues to command a premium, supported by higher return on equity (ROE) expectations, according to a report by Yes Securities.

India’s Valuation Premium Narrows

A significant trend emerging is the narrowing spread between the Price-to-Earnings (PE) ratio of Nifty 50 index and the broader EM index. This spread has declined to nearly one standard deviation (SD) below its historical average, marking a sharp reversal from its earlier highs when it exceeded +1 SD.

The 12-month forward PE trend further indicates a continued reduction in India’s valuation premium over EM, though it still maintains an edge due to stronger profitability prospects, the brokerage report said.

China’s Equity Reversal and India’s Relative Position

China’s stock market has witnessed a notable shift, with the CSI 300 index reversing its previous valuation discount. The PE ratio spread, which was in negative territory, has now entered a positive range, nearing +1 SD. This marks a significant change in sentiment toward Chinese equities, which were previously undervalued relative to the broader EM basket.

Meanwhile, India’s valuation premium over Chinese equities has significantly narrowed from levels above +2 SD in 2021 to around -1 SD today. Despite this relative de-rating, India continues to attract investors, backed by superior fundamentals and confidence in its long-term growth trajectory, the report noted.

Global Investment Rebalancing in Favor of EM

Beyond India and China, a broader rebalancing is underway between developed markets (DM) and emerging markets. The valuation premium of DM over EM has fallen from a peak above +2 SD to below +1 SD, signaling a possible shift in capital flows. With EM earnings growth outpacing DM in recent quarters, investors are increasingly eyeing EM opportunities.

India, with its projected 15% forward ROE, remains well-positioned to benefit from this evolving market landscape.

“India stands out with an expected 1-year forward ROE of 15%, better than many EMs, including Malaysia, China, South Korea and Philippines, ROE projection suggests that Indian markets may offer superior profitability prospects, potentially justifying its sustained valuation premium despite recent corrections,” Yes Securities said.

Meanwhile, earnings growth is turning relatively more favorable for the EM basket, justifying the narrowing of valuation differentials with DM. Year-over-year (YoY) profit growth for EM has improved over the last 9 months and is likely to outpace DM profit growth in the forthcoming quarter. This may support a re-rating of EM relative to DM, the brokerage report added.

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