Why India Stocks are Attractive right Now
Over the last 12 months, the MSCI India index (INDA), which tracks the performance of all large and mid-cap Indian stocks, rose by over 30%. During the same time period, stocks in China (MCHI) and Brazil (EZI)—two of the best-performing stock markets, were only up between 15% and 20%.
There are two main reasons for this strong performance in Indian stocks: (1) inflation in India has declined by about 3% from its peak in December 2013. As inflation declines, stocks and other financial assets become more attractive, and (2) investors’ optimism grew as it became clear that the reform-minded Hindu nationalist Bharatiya Janata Party (BJP) would emerge as the winner in the May national elections.
Since June, however, the rally in the Indian stock market has stalled as concerns over a global economic slowdown and a potential escalation of violence in Ukraine intensified. Investors are now asking: Will the strong rally in Indian stocks continue? Or will equity investors look for returns elsewhere?
We believe there remains strong upside in Indian stocks, as these long-awaited economic reforms will propel economic growth for years to come. Based on our research, we expect earnings of Indian companies to double over the next three years as economic growth accelerates.
The Bears’ arguments against Indian stocks are outdated
The bears’ arguments against buying Indian stocks typically go like this: Despite new Prime Minister Narendra Modi’s reform and economic development mandate, the much-ingrained corruption culture and inherent economic inequality will continue to sap India’s economic growth for years to come. With a highly educated and young labor force, and with an economy one-fifth the size of China’s economy, India’s economy should be growing at double-digits. And yet, India’s gross domestic product (GDP) only grew by 4.6% year-over-year in the first quarter of this year. Meanwhile, the Chinese economy grew by 7.4% year-over-year in the first quarter despite falling real estate prices and a slowdown in manufacturing and exports. India’s inflation rate has also been stubbornly high. India’s consumer price index (CPI) rose by 7.9% in July year over year, which is one of the highest among Asian countries.
Certainly, India’s history of corruption and lack of economic reforms have limited India’s economic and corporate profits growth in the past. However, our research shows that the bears’ arguments no longer apply, and that is why we are still bullish on Indian stocks over the next several years.
Why India is now embarking on a new growth spurt
The most important take-away from the recent national elections is that the Indian populace has grown weary of the ingrained corruption and economic inequality and now wants major reforms. Prime Minister Modi’s reform mandate is much more powerful since his party, the BJP, is the first party to hold a parliamentary majority in 30 years. The fight against cronyism is already evident. For example, Modi has warned his cabinet and state ministers against hiring family and relatives. Also, BJP cabinet ministers have been seen riding in smaller cars with no entourage and police escorts unlike those in the old Indian National Congress Party. These and other actions (such as the BJP’s graft investigation in India’s $74 billion healthcare sector) suggest that the new government is serious about fighting corruption and wasteful spending.
In our view, Modi’s recent unveiling of the latest budget is highly encouraging. While it was criticized for being lackluster and similar to the outgoing government’s interim budget, there are some important differences. For example, one factor that has sapped India’s economic growth has been the relative lack of infrastructure and other fixed asset investmentswhich resulted in a decline in gross capital formation, to just 30% of GDP last year.
This means that for every dollar of economic output, 30 cents is allocated to infrastructure investments and other fixed assets. For China, this percentage is consistently in the high 40s. This is one major reason why China’s economic growth has been consistently higher than that of India. The Modi government is thus responding by raising foreign direct investment caps for the defense and insurance industries from 26% to 49%, while offering tax incentives to investors in real estate and infrastructure.
Finally, India’s central bank has been adamant about its inflation-fighting stance, reiterating its 6% inflation target by January 2016. We see this as a realistic goal as reforms in private sector lending and infrastructure investments should boost India’s productivity growth in the foreseeable future. According to Goldman Sachs, the average valuation of Indian stocks is around 16 times earnings, which is close to its historical average. We believe these prices are cheap given our expectations for lower inflation and a doubling of earnings growth in India over the next three years. Investors who want to go on long Indian stocks could consider the following ETF's: (INDA) which tracks the MSCI India Index, (SCIF) which tracks Indian small cap stocks, and (EPI) which tracks the stocks of profitable Indian companies.
Based on our research above, we see realistic growth of about 15% to 20% in these (combined) investments over the next 12 months. Now, more than ever, is the best time to take advantage of India's new growth spurt.
Henry To, CFA, CAIA, FRM is Partner & Chief Investment Officer at CB Capital Partners. Established in 2001, CB Capital Partners is a global financial advisory and investment firm headquartered in Newport Beach, CA www.cbcapitalresearch.com
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