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Indian Stock Valuations at All-Time High

Investors continue to pour into the Indian stock market. The Nifty 50 Index, up more than 10% year to date, continues to reach new highs. Much of that is due to gains from cheap stocks, including many state-owned enterprises (SOEs) benefiting from government spending. Finding high-quality companies in the Indian market at attractive valuations therefore has become difficult.

One way to understand valuations is the required rate of return, which measures the minimum return for which investors will be willing to allocate capital. An outside view that we refer to is a valuation framework from UBS’ data-analytics platform HOLT that backs out the implied required rate of return investors are demanding from securities in the market, referred to as the market implied yield. At a country level, India’s median market-implied yield of 1.4% is at an all-time low for India and an all-time high premium relative to the broader EM index.

This is underscored when we look at the valuation across sectors. Current valuations are at the extreme point of the five-year range in all sectors, with the sole exception of Financials.

While India’s stock valuations remain high, regulators have highlighted a potential bubble, particularly in the mid-cap segment, and have attempted to limit further domestic flows into these stocks. And with regards to SOEs, we suspect the fundamental weakness of these companies will become apparent over time and that the superior fundamentals of high-quality, fast-growing businesses will once again be reflected in stronger stock prices.

India’s Net-Zero Progress

Maria Lernerman, CFA, portfolio manager for our Global Paris-Aligned and International Carbon Transition Equity strategies, recently traveled to India to observe the country’s emission reduction initiatives first-hand. In this video, she shares thoughts from her trip and highlights hurdles that the country must overcome to progress toward net-zero status.

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Japan’s Reforms Lift Stocks of Lowest-Quality Companies

Japan remains the single-largest country weight in the MSCI All Country World ex US Small Cap Index. However, the country’s weak economic growth, aging population, tight labor conditions, and chronic deflation have long made it a challenge to find high-quality, growing companies there.

Government regulators and the Tokyo Stock Exchange recently introduced a flurry of reforms aimed at improving corporate governance and shareholder returns. As discussed in our fourth quarter 2023 report, these actions have primarily benefited the cheapest stocks, given that they are typically associated with the least-profitable and slowest-growing companies. Additionally, the Bank of Japan has raised short-term interest rates, ending its decade-long era of negative rates. This landmark move boosted Japanese value stocks in the first quarter, further exacerbating the region’s style headwinds.

As the chart above to the right shows, the cheapest stocks in Japan outperformed the most expensive by nearly 1,600 basis points in the first quarter. For the trailing 12-month period, it’s worse: The spread between the most expensive and cheapest quintile was nearly 46%. The left and center charts show that investors also have favored slower-growing and lower-quality companies.

We don’t know how long this value rally will persist. In the short run, some of the changes have clearly exacerbated, and could prolong, style headwinds for higher-quality, faster-growing companies. But over the long term, the changes in Japanese business policy and mindset are positive developments. As more businesses raise their standards, the number of high-quality companies in Japan may increase.

India: Four Takeaways from Our Travels

With high GDP growth and a rapidly expanding industrial base, there is a lot of optimism about the Indian economy. And having passed China earlier this year as the world’s most populous nation, there is the potential for a “demographic dividend” to bolster that growth in the coming decades. Recently, three Harding Loevner colleagues traveled to India to talk to companies and see conditions on the ground for themselves. In the video series below, portfolio manager and analyst Jafar Rizvi and analysts Sean Contant and Chris Nealand discuss what they saw on their trip and their perspectives on India with portfolio specialist Apurva Schwartz.