Strategy and risk in Indian stock market
Indian equities trade at 3 times book value, writes Matein Khalid
India was the consensus overweight darling of emerging markets funds, even if the Sensex and Nifty indices have underperformed the asset class’s MSCI benchmarks for four months now. September was a disaster for Dalal Street as Indian equities fell 4 per cent, though the BSE Sensex is still up almost 24 per cent in 2017 for a US dollar investor.
India trades at a significant premium to the MSCI indices because it has domestic driven, not cyclical/export based earnings growth and due to the structural economic reform agenda of Prime Minister Naredra Modi’s BJP government. Despite the decline in India’s stock exchanges in September, Indian equities still trade at 18 times forward earnings and three times book value. This makes India the most expensive stock market in Asia, more expensive than Hong Kong (16 times forward earnings) or Japan (13 times forward earnings).
The Sensex’s 1.5 per cent dividend yield is the lowest of any major Asian stock market. This would not be a problem if the corporate earnings cycle was at its peak but EPS growth has now decelerated to 8.7 per cent and downward revisions to next years estimates are now almost certain, as is the norm for Dalal Street.
The valuation case for India must be analysed in a global context. The first synchronised global economic recovery since 2009 has meant that Wall Street, Europe and emerging Asian equities all trade higher end of their historic ranges. In fact, the premium of Indian equities to global indices or the bellwether Morgan Stanley Capital International (MSCI) emerging market index is nowhere near its peaks in 2007 and early 2008 on the eve of the global financial crisis.
Asia’s third largest economy is an oil importer and the sharp rise in Brent crude since the summer naturally will increase the oil import bill and thus the current account. Crude oil was certainly a contributory factor in the Reserve Bank of India (RBI)’s decision not to cut the 6 per cent repo rate at its last monetary conclave. The last GDP shock was also due to the impact of demonetisation and the Goods and Services (GST) tax on the Indian economy in 2017. Both these structural reform initiatives disrupted small businesses/traders or industries dependent on the cash/“black money” fringes of the Indian economy. Corporate India is also burdened with excessive debt that inhibits a new capex cycle. The non-performing loan crisis at Indian public sector banks is another structural impediment to a more robust capex cycle. While the rupee was a strong performer earlier in 2017, I expect the Indian rupee will depreciate to 66 as the Federal Reserve begins its balance sheet shrinkage and raises the overnight borrowing rate again at the December FOMC, thus boosting the US dollar.
The asset allocators in emerging market funds have favored China over India in the past four months, mainly due to cheaper valuations, better earnings momentum and monetary stimulus by the People’s Bank of China. China is also more leveraged than India to a synchronised global economic growth recovery.
There have been distinct money making opportunities in the Indian stock market. The IPO of ICICI Lombard was a huge winner, as insurance is a structural growth story in India. I see the decline of the rupee and the new “animal spirits” in global financial services as an opportunity to accumulate certain Indian blue chip IT services firms that have been mauled by the stock market. Modi’s assault on cash money has hit Indian property developers and will create new opportunities for money making in housing finance shares. Synchronised global growth and slightly higher local inflation is also an argument to accumulate Indian aluminium shares. Indian private banks have growth potential. Indian generic companies morphing into biosimilars/specialty drugs and rising margins will also attract investor interest.
The plunge in the Turkish lira after a diplomatic spat between Ankara and Washington and the dangerous geopolitics of Iraqi Kurdistan/Syria also demonstrates that emerging markets face rising risks in 2017. The 2013 “taper” comment by the Bernanke Fed caused a spike in US Treasury bond yields and a massacre in emerging market equities. As the Fed tapers for real, history could repeat itself and Indian equities will not remain immune from an emerging markets sell off. This will be the moment to buy the dip on Dalal Street.