India's Nifty 50: Priced for Perfection

India’s equities market enters 2016 priced for perfection.  By nearly any valuation measure, Indian stocks are more expensive than their peers, and even venerable markets like those in the U.K, U.S. and Japan.  India’s stocks are pricier than China’s, and greatly more so than stocks in fellow BRICs, Brazil and Russia (Figures 1-5). The other BRICs are China and South Africa. 

Essentially since January 1, 2006, investors in the Nifty 50 would have doubled their money with respect to what they would have earned by investing in Indian short-term securities.High valuation levels aren’t necessarily a bad thing, so long as they are justified by strong economic growth. Given the strength of India’s economy, which has been growing by 6%-8% year on year (Figure 6), it shouldn’t come as too much of a surprise that India’s stocks are expensive compared to China’s financially-heavy stocks that are beset by credit fears and a slowing economy. Nor it is it too surprising that India’s stocks look expensive compared to their American, European and Japanese counterparts, given the slow growth in the developed world. That said, the developed world’s stock markets compete with very low domestic short-term interest rates (nearly zero) and long-term bond yields (less than 3%), which is not the case for India, whose domestic investors can earn a fairly tidy 7.8% on a 10-year bond, or 5.5% in the short-term money market.

Figure 1: Indian Stocks Have Higher Price-Earnings Ratios Than Peer Markets.

Figure 2: Indian Stocks are also Expensive in Price-to-Cash- Flow Terms.

Figure 3: Indian Stocks also Trade at Higher Multiples of Price/Sales.

Figure 4: Indian Stocks also Trade at Higher Price-to-Book Multiples.

Figure 5: Indian Stocks also Feature Lower Dividend Yields.

Figure 6: India’s Growth Rate has been Rebounding While China’s has been Slowing.

That Indian equities are many times as expensive as Brazilian or Russian stocks shouldn’t come as a shock either given that India continues to grow while Brazil and Russia are mired in recession.  Brazil and Russia also have quite high domestic interest rates (above 10%), which justify their lower stock market valuations – something that cannot be said of the developed markets to which we compare the Nifty 50, India’s benchmark index for large companies.

What is of concern, however, is that for the Nifty 50 to perform well, India will have to deliver growth that is strong enough to meet market expectations.  This is going to be a challenge, but there are a few factors that will help.

Figure 7: India’s Private Sector Debt Pales in Comparison to China’s.

Among India’s strong points are low levels of private sector debt (Figure 7), lower oil prices (India is a big net importer), a reasonably stable currency/monetary policy, and a diverse basket of stocks.

Figure 8: Nifty 50’s High Weighting of IT Stocks Explains the Higher Valuation Levels, Up To a Point.

Sector / Market Index Nifty Fifty Bovespa FTSE China A50 Topix S&P 500® FTSE 100 (U.K.)
Financials 30.97% 33.66% 69.08% 17.21% 16.48% 23.36%
Industrials 10.41% 5.84% 13.42% 20.67% 10.05% 6.84%
Consumer Discretionary 1.67% 6.55% 6.10% 20.83% 12.89% 11.04%
Energy 11.74% 9.37% 3.02% 0.85% 6.50% 12.15%
Consumer Staples 10.06% 20.62% 2.69% 8.79% 10.06% 18.35%
Utilities 6.53% 5.49% 1.99% 2.13% 2.99% 4.53%
Telecom 2.23% 3.57% 1.43% 5.33% 2.43% 6.41%
IT 16.28% 4.03% 0.99% 10.14% 20.69% 1.51%
Materials 2.84% 10.47% 0.80% 6.36% 2.76% 5.46%
Health Care 7.27% 0.44% 0.47% 7.70% 15.15% 10.34%
Source: Bloomberg Professional (XIN9I, HSI, SPX and UKX), IMAP Function, Nifty Fifty Fact Sheet December 2015

One feature of the Nifty 50 that distinguished it from most other indices is the high weighting to IT stocks. IT stocks often have high valuation levels predicated on the assumption of strong growth in earnings, cash flow, and sales. Moreover, IT companies rarely pay dividends, preferring instead to reinvest profits into the business. This explains, in part, why the Nifty 50 commands higher valuation ratios than competitors in China, Europe, Brazil or Russia, but not why Indian stocks would command higher ratios than stocks in the U.S. which are even more tech-heavy than India, and where interest rates (and to be fair, growth rates) are significantly lower. This leads us back to our bottom-line on Indian stocks: they are priced for perfection.

Given the industry weightings, it’s not too surprising that the Nifty 50 has reasonably high correlations with the S&P 500®, the tech-heavy Nasdaq 100 as well as the Technology and Financial sub-indices of the S&P 500®. The Nifty 50 has lower correlations with energy stocks, consumer staples, and utilities, and with Chinese stocks (Figure 9). Investors in China might see India as a good diversifier and vice versa. The Nifty 50 has exhibited strong correlations with Brazil and Russia as well as with Japan’s Nikkei 225. Correlations are unstable, however, and should not be expected to remain the same over time.

Figure 9: The Nifty 50 versus Various Indices and Sub-Indices.

Correlations (Montly) April 2011 - December 2015
Index Correlation
S&P 500® 0.58
Nasdaq 100 0.59
S&P E-Mini Financial Select 0.58
S&P E-Mini Energy Select 0.36
S&P E-Mini Technology Select 0.57
S&P E-Mini Industrials Select 0.54
S&P E-Mini Health Select 0.47
S&P E-Mini Consumer Discretionary Select 0.54
S&P E-Mini Consumer Staples Select 0.32
S&P E-Mini Utilities Select 0.09
S&P E-Mini Materials Select 0.54
Nikkei 225 (Japan) 0.51
FTSE China A50 0.15
FTSE 100 (U.K.) 0.53
Bovespa (Brazil) 0.51
RTS (Russia) 0.48
Source: Raw Data from Bloomberg Professional (ES1, NQ1, IXA1, IXP1, IXT1, IXI1, IXC1, IXY1, IXR1, IXS1, IXD1, BZ1, VE1), conracts rolled 5 days prior to expiry.
Calculations: CME Group Economics Research

One last note: there is an advantage in looking at any equity market from the perspective of rolled futures contracts rather than price indices.  Unlike the price index, the rolled futures return takes into account the cumulative impact of dividend yields and subtracts the opportunity cost of capital from the short-term rate.  Essentially since January 1, 2006, investors in the Nifty 50 would have doubled their money with respect to what they would have earned by investing in Indian short-term securities.  This represents a respectable 7.1% compounded excess return over the past decade.  Given the Nifty 50’s high valuation levels, for Indian stocks to perform equally as well in the next decade relative to returns on cash instruments, things will have to come up roses.

Figure 10: 7% Annualized Average Excess Return Since 2006, But Can it Continue?


All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only.  The views in this report reflect solely those of the authors and not necessarily those of CME Group or its affiliated institutions.  This report and the information herein should not be considered investment advice or the results of actual market experience.

About the Author

Erik Norland is Executive Director and Senior Economist of CME Group. He is responsible for generating economic analysis on global financial markets by identifying emerging trends, evaluating economic factors and forecasting their impact on CME Group and the company’s business strategy, and upon those who trade in its various markets. He is also one of CME Group’s spokespeople on global economic, financial and geopolitical conditions.

View more reports from Erik Norland, Executive Director and Senior Economist of CME Group.

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