1 June 2018

Indian Equities: Charging Bull or Raging Bear?

Recent macroeconomic trends are creating value stocks with upside potential

Photo by Swapnil Deshpandey from Pexels

By Howard James

When glancing at either the S&P BSE 100 or the NSE Nifty 50 indices, there’s nothing out of the ordinary when comparing them to their peers from around the world: record highs following five years of growth with much volatility in between.

Investor sentiment, however, is ambivalent.

On one hand, the stock market’s size and the scale of the nation’s economy are good enough reasons to gain exposure to Indian equities — market capitalisation at the time of writing stands at about $2.2 trillion, according to Bloomberg, with GDP worth $2.6 trillion in 2017 and a growing population of more than 1.3 billion, according to the World Bank. Yet on the other hand, the nation’s widely acknowledged inability to move beyond age-old structural issues is stalling growth of the Indian economy and the very companies that prop-up the nation’s stock market.

Of India, Oppenheimer Funds cautions: “Despite its tremendous growth potential, it still faces considerable challenges in its journey to becoming an industrialised, modern economy — many of which are self-inflicted.”

Structural Woes

With the informal sector accounting for 80% of jobs, no one, including the Government of India (GOI), knows the exact value of the Indian economy. Recent attempts to better control and understand the circulation of money have, to date, borne fruitless results, the nation’s media universally claim. And with inflexible and grossly outdated labour laws, many companies are crippled by bureaucracy, which has made them vastly inefficient and unproductive, reports The Economist.

Of particular note is how hard and soft infrastructure has been starved of the necessary investment needed to fulfil India’s vast socioeconomic promise. Despite consolidated public sector debt standing at 6.6% of GDP in 2018 and outstanding consolidated government debt at 68% of GDP, according to the Reserve Bank of India (RBI), infrastructure programmes, and services in healthcare and education, remain greatly underfunded, says the World Bank.

“The election of Prime Minister Narendra Modi a few years ago was accompanied by high hopes that reform would address these and other challenges. However, those hopes have given way to the cold, hard reality that unwinding the government’s excessive, and often obstructive, involvement in large swathes of the economy — banks, transportation, energy — will be a herculean task,” Oppenheimer Funds remarks.

Resulting from all of the above, investors have largely remained hawkish on Indian equities of late, despite their gradual rise over the past five years.

Are Indian equities on the cusp of a bear market?

Recent developments say otherwise.

Changing Demographics

Like other emerging markets, India is experiencing rapid urbanisation and a rising middle class. Indians are saving more now than before: currently national savings stand at more than 30% of GDP, according to GOI, which in turn can be invested into hard and soft infrastructure projects and capital stock.

India’s urbanisation potential is particularly noteworthy. Presently, 70% of the nation’s population reside in rural areas with limited access to formal education, according to the Ministry for Labour and Employment. By 2050, the proportion of people living in cities versus those who live in rural areas will be split equally, predicts the GOI — that’s 750 million a piece by this date. With India’s cities providing schools and universities, Indians will become more literate and better educated. This will have positive impact on the economy and ultimately the performance of companies.

Urbanisation will also reduce the size of India’s informal sector, which currently comprises about 80% of the nation’s population, or 1.1 billion people.

Rising Indicators

Following years of volatility, fixed asset investment has been steadily rising since mid-2017, according to RBI. Indian companies are investing in machinery and other physical goods to become more productive and profitable. Fixed asset investment presently stands at US$25 billion per year. Productivity has been an acute issue for Indian firms of late. Nonetheless, capacity utilisation increased to 75.2% in Q1 2018 from 74.6% a year earlier, and the nation’s industrial production index rose by 4.2 points during the same timeline, RBI states.

Infrastructure investment is finally flowing, albeit at an incremental pace. For instance, the roads sector was awarded INR 1.4 trillion (US$20 billion) during 2017 to build new projects, and the housing sector is seeing the implementation of a INR 2.5 trillion (US$35 billion) urban housing programme.

Emerging Stocks, Strong Fundamentals

While the MSCI India Index performed valiantly during 2017, growing more than 30% within this timeframe, the performance of each company within the index was mixed. In fact, 26% of the Index’s returns came from just three companies: Reliance Industries, Housing Development Finance Corporations (HDFC) and Infosys.

HDFC performance has been noteworthy, illustrating the polarised fortunes of privately-owned financial firms versus state-owned banks. Following years of solid growth, its stock price at the time of writing stands at INR 1,938 (US$27), more than doubling its stock price of INR 760 (US$10.5) five years ago. By contrast, publicly-owned State Bank of India reached its record stock price of INR 342 (US$6) in November 2010, dropping to INR 149 (US$2) five years ago and gradually recovering to INR 297 (US$2.7) today.

There are many such diamonds in the rough, some managers argue, which can be found across various sectors. “In an emerging market like India where there are many risks, a deep understanding of the businesses at microscopic level helps immensely. The strength of the business model, the people running the business, and the valuation to be paid are the three most important criteria we evaluate,” explains PineBridge Investments in a recent report.

Currency Sell-off

Market commentators have been quick to note that the rupee is Asia’s worst performing currency this year, having fallen 10% this year against the US dollar. However, the new rate of about 71 to the greenback at the time of writing makes exports and domestic stock prices cheaper. Granted, this new low will make imports more expensive, but India is increasingly a key exporter of high-value goods and services in areas like ICT and pharmaceuticals.

Although many individual stocks from these sectors have held high share prices for some time, today’s lower exchange rate — coupled with emerging names that are increasingly attractive from a valuations perspective — means that such companies are worth researching further.

Will investors witness a nationwide bull run into 2019 and beyond? Likely not, but rather a market with select stocks exerting significant upside potential.

Strategy, Thought leadership