The Indian equity market – one of the best performing markets in the world last year – appears poised to continue growing at full steam. “The prospects for the Indian market are very good, especially for the long term investor,” says Mark Mobius, Singapore-based executive chairman of Templeton Emerging Markets Group. “In general, all sectors would show multi-year growth” – even at current valuation levels – “as it is a nascent opportunity,” he adds.
In 2014, India’s BSE SENSEX Index made a gain of 41.1%, compared to MSCI Emerging Markets Index which was up 7%, the S&P 500 Index 24.3% and the S&P TSX index 12.3% – all in Canadian dollars.
Looking ahead, “we are optimistic about the performance of the SENSEX, with a general base case target of 38,700 in two years, compared to 29,000 today,” says David Kunselman, senior portfolio manager with Excel Investment Counsel in Mississauga, manager of the Excel India Fund, the largest mutual fund in Canada focused on investing in India.
Bank of America Merrill Lynch (BAML) is also optimistic about India. In its January 8, 2015 India strategy report, the investment house projects a gain of nearly 20% this year and forecasts that the market will almost double to 54,000 by 2018.
Allaying fears that the 2014 performance of the Indian equity market was not a one-time event, the report stated that of the previous 9 times the Indian markets produced a return greater than 30% – as it did last year – it provided a positive return on 7 of the following 9 occasions, averaging 22%. It also indicated that market performance in the second year of a new government has been positive on five of the last six occasions between 1991 and 2009, returning an average of 25.8%.
Can the Indian Equity Market Get Back to its High?
Incidentally, India’s first majority government in 30 years, led by Prime Minister, Narendra Modi, came to power last year.
Although he sees opportunity in India, Chuck Bastyr, vice president and portfolio manager with Mackenzie Investments in Toronto believes “stocks are expensive,” given the run-up in the market.
“A lot of stocks have rallied in anticipation of growth in earnings,” says Matthew Strauss, global strategist and portfolio manager with CI Investments Inc. in Toronto. However, he contends that “there is opportunity to get into the market even at these valuation levels.” He believes earnings growth will contribute to stocks not appearing “exorbitantly expensive” but cautions that “there is not a lot of margin for error” when relying on earnings growth to make investment decisions. “Even if companies do well in 2015, their earnings might not be enough to support valuations.”
Currently, Indian equities are trading at an average price earnings ratio of approximately 15.7 times, which is in line with the market’s 10-year average but way below its 2008 high of almost 25 times. Kunselman anticipates that “corporate earnings will grow at a compound rate of approximately 17% per annum for the next 5 years and that the equity markets will mirror the strong earnings growth.”
“The performance of the stock market has been influenced by foreign investors who hold 20% of the market,” says Mobius. However, “we are now seeing the local investor moving into equities.” He adds “the keys” to the market’s continued strength “will be earnings upticks backed by lower input costs as well as inflows into equities by locals and continued support by foreign investors.”
The strength of India’s equity market is underpinned by several macro factors. Rishikesh Patel, London, England-based, portfolio manager with LGM Investments, a division of BMO Global Asset Management Inc. in Toronto, says “the stars are aligned for India” which is benefitting from massive government reforms; lower commodity prices, especially for oil which is one of its largest imports; rising corporate profitability; a growing middle class; and a demographic dividend characterized by a youthful population.
The government’s reform program proposes massive infrastructural development in areas such as roads and railways, improvement in the legal, tax and regulatory frameworks, greater mobility of capital, and increased foreign and private investments.
There has been “a change in investors’ mindset” resulting from Modi’s promise “to streamline everything, remove red tape and lessen the country’s bureaucracy,” suggests Bastyr. He says “Modi is like a pit bull but he is a strong leader and most people like him.”
Bastyr also suggests that Modi believes he can replicate his successful track record as former Chief Minister of the State of Gujarat, whose GDP grew at an average rate of over 10% for more than a decade under his leadership.
Incidentally, the World Bank, in its January 2015 Global Economic Prospects report forecasts India’s GDP growth at 6.2% in 2015, up from an estimated 5.5% last year. Growth will be fuelled by increasing consumption, higher infrastructure spending, and greater exports from manufacturing, says Kunselman. The government will also reduce subsidies, contributing to an improvement in its fiscal balance; while lower oil prices will result in a reduction in the current account deficit to possibly a current account surplus in 2015,” he adds.
Falling inflation, resulting from lower oil prices will lead to lower food prices, providing more disposable income in the hands of consumers, says Kunselman. “It will also contribute to lower interest rates.” The Reserve Bank of India cut interest rates by 25 basis points in January and analysts believe another 75 basis points of cuts are on the horizon for 2015.
Mobius believes “the key drivers of growth would be the ability of people to organize themselves to achieve higher per capita incomes and the government’s ability to open up the economy.” He contends that “India has a great talent pool” but “was being held back by several factors, including “bureaucracy and high global costs of commodities.”
Managers investing in India see opportunity in various areas such as consumer goods, technology and pharmaceuticals but banks, financials, and infrastructure and related industries are among their favourite areas.
Kunselman says banks are benefitting from an improving economy, lower loan losses and increasing net incomes. He holds State Bank of India, ICICI Bank Limited, HDFC Bank Limited and Yes Bank Limited. Bastyr also holds HDFC, as well as Indiabulls Housing Finance Ltd. which he sees as an “aggressive newcomer” to the financing space. Patel is also invested in HDFC and Yes.
In the infrastructure space, Strauss is invested in Adani Ports Limited, one of India’s largest multi-port operators, Larson and Toubro Limited, the country’s largest engineering and construction company and Shriram EPC Limited which provides engineering solutions. Kunselman owns IRB Infrastructure Developers which is involved in the construction of roads and highways.
While India is set to do well, risks remain. Mobius says the biggest risk for India is that companies and the country take their success for granted and expand too quickly and excessively; and that the rise in government spending could lead to increased bureaucracy which would eventually dampen growth.
Strauss cautions that reforms can face setbacks as this is not the first time that they have been proposed but failed. He also says that a tightening of global liquidity could lead to a reversal of fund flows from India.
But the biggest risk is perhaps Modi himself. What if he is no longer in the picture?
(A version of this article first appeared in Investment Executive)