Avant Garde Wealth Management’s fourth quarter letter- has a section on India’s valuation in a global context.
Market cap to GDP – India’s valuation in a global context
In last quarter’s letter we had looked at a time series of India’s market cap to GDP ratio (M:GDP). An updated version of that graph is below, which shows that the ratio has gone up from 83% to 88% in the last four months and is close to one standard deviation above its historic average.
Given the globalization of financial markets investors have the ability to allocate their capital among countries. Hence, taking the above analysis a step further we look at the trend of M:GDP of the world as a whole over the years. And also look at how India’s M:GDP compares to the global figure over time in order to get a sense of India’s relative valuation compared to the rest of the world.
As shown in the following chart, over the last 25 years, global M:GDP has been in the range of 45% to 115%, with a current value (as of Dec 3, 2014) of 85%. The US is by far the dominant influence, constituting 23% of global GDP and 43% of global market cap. By comparison, China constitutes 13% of global GDP and 6% of global market cap.
China’s equity market performance over the last few years has been dismal relative to its reported GDP growth. So unsurprisingly, excluding China from the above analysis makes the current ratio look slightly higher relative to its history.
Around the turn of the century the ratio of India’s M:GDP to global M:GDP (shown below) was around 0.3x. This ratio went as high as 1.25x in 2007 and now sits at 1.05x.
Readers know that we have been wary of downside risks in global equity markets, led by the USA. In the context of relative valuation, India’s M:GDP ratio may not have much higher to go relative to the rest of the world. So in case of a meaningful correction in global equities the Indian market may not prove particularly resilient, irrespective of domestic fundamentals. Additionally, if for some reason there is an adverse change in investor perception of India, and the Indian M:GDP to global M:GDP ratio mean reverts towards 0.6x from 1.05x currently, there is potential for a significant decline in Indian equities. While the latter scenario seems to have low probability as of now it is worth keeping in mind.
See full PDF here.