India's Market Meltdown: A 27-Year Low in Relative Performance – What Jefferies Predicts Next

Indian equities have found themselves in an unprecedented slump, recording their worst one-year relative performance against both emerging market and global peers since a staggering 1996. This significant underperformance has sent ripples through the investment community, prompting a closer look at the market's foundations and what lies ahead.

The numbers paint a stark picture: the Nifty 50 has substantially lagged behind the MSCI EM index, which itself has faced challenges, and even more so against the robust MSCI World index.

This prolonged period of relative decline has spurred analysts, including those at Jefferies, to dissect the underlying causes and forecast potential trajectories.

Jefferies' comprehensive analysis delves into India's market cap, which, despite the recent correction, still stands at 1.7 times its GDP.

While a dip from its peak of 1.9x, it remains notably higher than the 1.1x seen during the 2008 financial crisis or the 1.3x in 2013. This suggests a more resilient fundamental base than prior downturns. Furthermore, while the equity risk premium (ERP) appears compressed, the earnings yield gap (EYG) tells a more optimistic story, indicating a better valuation stance compared to 2008 levels.

Crucially, corporate earnings growth has shown promising signs of improvement, laying a stronger foundation for future performance.

However, the path forward is not without its hurdles. Jefferies identifies several significant headwinds that have dampened investor sentiment and performance. Persistent foreign institutional investor (FII) selling has been a major drag, compounded by sticky inflation, rising interest rates, and a depreciating rupee.

The specter of a global growth slowdown further adds to these concerns, creating a complex operating environment for Indian businesses.

Yet, amidst these challenges, powerful domestic tailwinds offer a counterbalance. Robust domestic liquidity, driven by local investors, continues to provide crucial support to the market.

India's improving macroeconomic fundamentals, including a narrowing current account deficit (CAD) and a disciplined fiscal deficit, present a more stable economic backdrop. Coupled with a promising trajectory in corporate earnings, these factors provide a beacon of hope for a potential market recovery.

From a valuation perspective, the Nifty's 12-month forward price-to-earnings (P/E) ratio currently stands at 18.5x.

This represents a 15% premium over the MSCI EM index, which is noteworthy. However, it's also below its five-year average of 19.3x and even slightly under its ten-year average of 18.4x, suggesting that valuations might be becoming more attractive following the recent correction.

Looking ahead, Jefferies recommends a strategic shift for investors.

Their focus is firmly on domestic cyclicals, particularly sectors like banks, automobiles, and infrastructure, which are poised to benefit from India's internal growth drivers. They are overweight on financials, discretionary consumption, and industrials, anticipating strong performance in these areas.

Conversely, they advise an underweight position on IT services, materials, and utilities, aligning with their broader market outlook. Navigating this dynamic landscape requires careful consideration, but with expert insights, investors can position themselves to capitalize on India's evolving market story.