India’s troubled stock market is priced for perfection

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Stock markets have defied the odds this year. A war of choice, an energy shock, resurgent inflation, political uncertainty, rising bond yields. You’d be forgiven for thinking that investors would be running for the hills. But, no, the glass remains half full.

Had you invested £100 at the start of the year in the S&P 500 you’d have £108 today, £103 in the FTSE 100, £102 in Europe. Go further afield and you have grown your money to £121 in emerging markets and £125 in Japan. If you had gone all in on the AI boom, you could have turned your £100 into £145 in Taiwan or £181 in South Korea. Crisis, what crisis?

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But there is usually an exception that proves the rule. And the current outlier is a stock market that has served investors well over the long run but poorly year to date. If you had directed your £100 to India this year, you’d have £87 today. Almost uniquely, investors in Mumbai have got the bearish memo.

With markets looking a bit complacent, amid echoes of previous booms and busts, this feels like a good time to be exploring contrarian opportunities. And some investors are starting to make the case for a market that has been comprehensively left behind. Is this India’s time to shine? Not yet.

The list of reasons to consider investing in India is, on the face of it, encouragingly long. First, the country is home to one of the world’s fastest-growing economies - GDP is expected to expand at 6-8% annually, driven by a uniquely favourable combination of growing domestic consumption, a young population and supportive structural reforms and investment.

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A median age of 29, 1.4 billion people and a rapidly urbanising population makes strong economic growth sustainable. India’s GDP has grown ten-fold since 1980, but it is still only on a par with China in 2006, on a per capita basis.

The growth in the number of households enjoying the kinds of incomes that support spending on vehicles, consumer electronics, financial services and property is likely to be strong over the next few years. And, in many cases, these industries are starting from a low base. There are roughly 60 vehicles per 1,000 people in India, compared to 230 in China and 850 in the US. Just 3% of households have a credit card in India, versus 69% in America.

India is a relatively stable democracy. And its government is providing the kind of policy support that drives innovation and productivity, expanding both physical and digital infrastructure. Despite India’s economic transformation, and a long-established stock market, ownership of equities remains low. Just 6% of Indians invest in stocks. This is an emerging market that is still emerging.

So, why has India been such a disappointment of late? Well, just as the country is in the long-term sweet spot for investors, and has outperformed most of its counterparts - emerging and developed - over the past 20 years or so, it also finds itself uniquely badly placed more recently. India has had to lean into a daunting set of headwinds in the past year or so.

India is particularly vulnerable to foreign investor sentiment, which has soured since the start of the Iran war. Overseas investors have liquidated more than $20bn of Indian shares since the start of March, reducing foreign ownership to a 14-year low. It is not hard to see why. If you were looking for an obvious victim of curtailed oil supplies and soaring energy costs, then it would not take you long to alight on India.

It is the world’s third largest importer of energy and relies on other countries for 90% of its oil and gas requirement. Most comes from the Gulf states. Spending more than $170bn a year on energy imports, the rising cost of oil and gas has widened India’s trade deficit and pushed the country’s current account deficit to 2% of GDP.

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It is little wonder that Prime Minister Narendra Modi this week called on Indians to curb their love affair with gold and stop buying the precious metal for a year to preserve foreign-exchange reserves. Gold is the second largest contributor to India’s import bill after oil. No surprise either that, at 95 to the dollar, the rupee has never been cheaper. That, in turn, has deepened losses for overseas investors whose Indian assets are worth less in their home currency.

At the same time as its costs are rising, one of India’s main exports, software services, is under pressure as AI threatens its market. Unlike Korea and Taiwan, whose dominance of semiconductor manufacture has allowed them to ride the coat tails of the AI boom, India’s expertise lies in the most vulnerable corner of the tech sector.

But the biggest reason not to expect an imminent rebound in the Indian stock market is that, despite its underperformance this year, it remains one of the world’s more expensive investment destinations. India has always been one of the most popular emerging markets but at its peak a couple of years ago it vied with the US for top spot in valuation terms.
Even now, Indian shares cost around 20 times forecast profits, according to estimates from Goldman Sachs. That is about twice as expensive as China and a 25% premium to Japan. It is about three times the valuation of the Korean market.

Prime Minister Modi is not alone in seeing trouble ahead. Analysts have started to adjust their earnings forecasts in response to the energy shock. Cyclical areas - industrials and consumer stocks - are in the firing line. And that sits uncomfortably with a market that still looks to be priced for perfection.

This article was originally published in The Telegraph

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