The Indian stock market continues to defy skeptics as investors have been pouring money on hopes of structural reforms and economic rebound. Stocks' gains earlier this year were mainly driven by optimism over the new pro-reform, business-friendly government led by Prime Minister Narendra Modi.
After elections, Indian stocks took a breather for a little while as some investors looked for opportunities to book profits after a strong surge and some were disappointed by weaker-than-expected measures announced by the government in the budget. But that did not last long. (Read: 3 Ultra Cheap Value ETFs for Long Term Outperformance)
A positive earnings season and strong economic growth propelled the stock market into record territory again and many analysts now believe that Indian stocks are still attractive considering earnings' growth prospects in the coming years.
Improving Macroeconomic Conditions
During April-June fiscal quarter, Indian economy expanded by 5.7%--the best growth rate in two years, a with marked improvement in manufacturing and industrial production.
Inflation is now lowest in almost two years and slowly coming down towards central bank's target, thanks mainly to the aggressive steps taken by the central bank governor Raghuram Rajan last year and earlier this year.
Current account deficit has narrowed sharply with rising exports and declining imports. Restrictions imposed last year on gold imports have been the main contributor in bringing down the trade and current account deficits. (Read: Solar ETFs Hot Again, Brighter Days Ahead?)
Better-than-expected Corporate Earnings
During the recent fiscal quarter (April-June), corporate earnings came in better-than-expected. Net profits of 30 largest companies grew 19% in the quarter. The auto industry is now witnessing a nice pick-up as the consumer sentiment has improved.
Financials' outlook is also more positive now as asset quality is expected to improve with the
economy recovery. A large number of steps taken by the central bank towards making the financial sector healthier and more open have improved the long-term prospects for the sector. The energy sector should also improve with reforms being considered by the new government.
Reform Hopes
Stocks market gains in the coming months will depend on the government's policies and actions, as investors continue to pin hopes on reforms promised by the Modi government. (Read: 3 Growth ETFs to buy on large Cap Surge)
Strong steps towards improving infrastructure and manufacturing industry, encouraging foreign investments and introducing critical structural reforms would go a long way towards keeping investor hopes alive.
Further with a central bank committed to keeping inflation and current account deficit on track, India's long-term outlook certainly appears to be brightening.
What are the Risks?
Weaker-than-expected monsoon season in India has raised the risk of inflation picking up again. Further, the government is likely to cut spending as it struggles to bring the fiscal deficit down, which may hurt growth. At the same time economic growth may boost tax revenues, helping the government achieve its target of bringing down the fiscal deficit to 4.1% of GDP by the end of the current fiscal.
India is largely dependent on imports to meet its growing energy needs, leaving the economy vulnerable to any oil price shocks. Higher oil prices—resulting from escalation of tensions in the middle-east—could put some pressure on the recovery.
As the Fed is expected to start raising rates next year, many investors are concerned about the imapct of higher rates in the US on emerging markets. However Indian stocks and the currency now seem much better positioned to withstand the shock.
A look at other Emerging Giants
At this time, India appears to be the only shining star among the group of emerging giants--popularly known as the BRICs.
China—the world's second largest economy continues to face headwinds--raising doubts whether it will “manage” to achieve its growth target of 7.5% this year. The health of its financial system also remains a big concern in the mind of investors.
Brazil's economy has already suffered two consecutive quarters of contraction and the recent data points to continued weakness in the current quarter as well. The only silver lining there is the dimming hope for President Dilma Rousseff's re-election.
Russian stocks look enticingly cheap to some but given enormously high level of political risk, they are suitable for dare-devil investors only. Further the Russian economy looks quite weak as of now.
ETFs to Consider
ETFs focusing on small cap stocks—EGShares India Small Cap ETF (SCIN) and VanEck India Small Cap Index ETF (SCIF)—were big winners earlier this year but have underperformed the large cap India ETFs in the last couple of months. They look attractive for long-term investment, given their focus on the growing middle class in India. Further, they are more immune to global economic twists and turns compared to their large cap cousins.
Investors should also look at WisdomTree India Earnings Fund (EPI) which holds profitable companies using an earnings-weighted methodology. Its focus on cyclical and some exposure to small cap stocks make it well positioned to benefit from the recent positive trends.
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EMERG-GS INDIA (SCIN): ETF Research Reports
MKT VEC-INDI SC (SCIF): ETF Research Reports
WISDMTR-IN EARN (EPI): ETF Research Reports
ISHARS-SP INDIA (INDY): ETF Research Reports
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