Quick Market Update
December 10, 2013
Ron Florance, CFA®
Deputy Chief Investment Officer
Sean Lynch, CFA®
Global Investment Strategist
In this Quick Market Update:
Observations from our India trip
This weekend’s election results show that many Indians are anxious for political change.
As India recovers from its mid-year slump, economic growth is expected to trend higher, but is unlikely to reach the post-recession highs of eight to nine percent any time soon.
Abundant crops this year could help to constrain Indian inflation in the coming months.
Maintain neutral allocations to emerging markets and Indian assets in particular.
An economy bottoming out and trying to gain traction…worries over political paralysis…markets on edge responding to the latest elections…Are we talking about the United States? Maybe. But this is also the prevailing environment in India, one of the world’s leading emerging markets. We are currently in India analyzing the business climate and economy as part of our global research efforts. In this Quick Market Update, we review the recent election results, discuss our outlook for the Indian economy and markets, and share investment insights gleaned from our meetings here.
This past Sunday, December 8, the election results in four key India states were announced. The challenger, the Bharatiya Janata Party (BJP) national party, and its charismatic leader, Narendra Modi, proved victorious in all four elections. Why are election results in India important for global investors? Global investors likely have some exposure to India markets, and the results of Sunday’s elections led to strong performance in the Indian markets. Since its low point on August 21, the Sensex Index—the benchmark index of the Bombay Stock Exchange—has increased over 19 percent, making India’s equity markets a key positive outlier among other emerging markets over the past few months. The two major Indian benchmarks stand near record highs despite the many economic, political, and social concerns impacting the country. Now that the elections are over, however, India, alongside the rest of the emerging markets countries, will have to once again digest fears that the U.S. Federal Reserve may soon taper its bond buying activity, in addition to concerns about other central bank policy maneuvers in the developed world.
The Sensex Index’s strong performance in the past few months serves as a positive outlier
Source: Bloomberg, 12/09/13
India is one of those countries where sheer numbers can be staggering sometimes. For example:
74.5 percent of the 11.9 million total voters in the state of Delhi voted in this election. There were 405,000 people voting for the first time. This is hardly voter apathy in the world’s largest democracy.
Indian GDP growth should bottom out this year at 4.8 percent, a growth rate that would make many developed countries envious. Judging from the discussions we had with business leaders, government officials, and economists in Mumbai and Delhi, most believe that, in spite of policy mistakes, India will continue to grow at an annual rate of at least 4.5 percent. With renewed optimism as a result of the elections, India’s growth rate could trend higher, but is unlikely to reach the eight to nine percent post-recession highs any time soon.
Over the next 10 years, approximately 240 million people will enter the Indian labor force.1 The ability to absorb such a large number of job seekers is one reason why growth is so important to the Indian economy. It is also why the economy (under the right conditions) can grow at a high rate without sparking labor-related inflation.
India turning the corner
Despite the BJP’s strong showing in this weekend’s local elections, victory in May’s national elections is not guaranteed; much can change in the coming months. Nevertheless, political waves can be hard to stop. The results from this weekend clearly spell trouble for the incumbent Indian National Congress (Congress) party led by the current Prime Minister Manmohan Singh. The Congress party has been in power since 2004, and many attribute the country’s deceleration to its poor policy making. The winner of the May elections will still have to form a coalition government, but the turnout for Sunday’s state elections shows that enthusiasm for real change is afoot.
Some other key components to India’s economic health are its environment and weather. This year’s monsoon rains were good, leading many to expect a plentiful harvest this year. Ample crops should help to reduce India’s inflation rate, which climbed to seven percent in October largely driven by higher food costs. For example, the price of onions, a vital staple in Indian cuisine, soared at an annualized rate of over 278 percent in October, and prices of vegetables soared 78 percent during the same time period.2 With a more abundant harvest and fewer government inefficiencies due to the expected policies of India’s new leadership, expectations for inflation should decline to a more sustainable five percent level.
Lastly, one observation that has surprised us is the lack of panic around the summer swoon in the rupee and other emerging-markets currencies. By the end of August, the rupee had declined more than 20 percent before rebounding this fall. The currency suffered as foreign investor outflows increased following the U.S. Fed’s comments in May about tapering. With the strong jobs number reported this past Friday in the U.S., will renewed fears of tapering result in another leg downward for the rupee? Possibly, but few see the value of the rupee deteriorating further than it did this summer. India has had several months to rebuild investor confidence. One way it has done so is by improving its current account deficit by enacting certain policy measures, such as limiting gold imports. Also, investors here have commented that a weak rupee isn't all bad for India as it makes exports more competitive. It has been estimated that nearly 40 percent of the companies that make up the Sensex Index benefit from a weakening rupee. Recently, we have seen foreign inflows of capital turn positive once again.
Our tactical recommendation is neutral for emerging market equities, bonds, and for Indian assets specifically. At the beginning of our Indian trip, we thought that the conclusions we were likely to draw would be more pessimistic. We were having difficulty rationalizing the political dysfunction and economic turmoil with the new highs the stock market was reaching. As our meetings progressed, however, we began to see why the equity markets, a forward-looking mechanism in any country, have begun to show significant improvement. Economic optimism is returning to India, but may already be reflected in current asset prices. Valuation is not especially compelling given that the Indian stock market is trading at 15 times earnings for 2014, which happens to be the historical five-year average for this index. As with many other emerging markets, above-average economic growth rates have not translated into strong corporate-earnings growth. Instead, corporate earnings in India have remained subdued over the past five years, and profit margins are near 20-year lows. At these levels, the earnings cycle may be bottoming, but a meaningful increase in earnings may be a few years out.
One of our most profound impressions of India is the strong aspirational nature of its people. Their view is that life only goes forward, not backwards. Progress in this vast country will be challenging and lumpy. We will include more of our observations about India’s expanding bond market, its currency (rupee), gold demand, and the country’s battle with inflation in an upcoming special report that will be published in the first quarter of 2014.
India is a key barometer for emerging and frontier markets—a group of markets that has fallen out of favor with global investors this year. As with any region or asset class, the time to revisit such investments is typically when interest wanes. As the buoyant equity market is anticipating and the latest election results are showing, India is beginning to reawaken.
All data for this Quick Market Update was sourced from Bloomberg Finance, LLP, unless otherwise noted.
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1 Source: UTI Asset Management Company, 12/13
2 Source: VN, Sreeja. "Record High Prices Of Onions In India, Which Soared More Than 278% In October, Limits RBI's Room For Rate Cuts." International Business Times 19 Nov 2013 Web.