Is India the world's best growth story?

Investors’ love affair with India cooled significantly last month. Foreign investors sold US$11bn worth of Indian shares, the fastest rate of disposals ever for the country’s stock market. The sell-off contributed to a 6 per cent fall in the value of India’s two main indices, the Sensex and Nifty 50. The rupee has also fallen out of favour as investors fret about slowing growth and sky-high valuations that had made India an even more expensive equity market than the US.

An economic slowdown and disappointing corporate profits growth have left investors questioning whether they should cash in their chips in one of the highest-octane stock markets of the past couple of decades. If you had invested $100 in Indian shares in 2004, you would have around $1,200 today, even after last month’s dip. That compares with about $300 if you had opted for the more obvious growth story at the time of Chinese shares.

A 6.7 per cent annualised rate of expansion in the three months to June might look like a nice problem to have. But that was the slowest growth rate in around 15 months, and it has led to nearly half of India’s quoted companies failing to match analysts’ expectations. Goldman Sachs said this week that 46 per cent of the companies it tracks failed to hit the market’s forecasts in the latest earnings round.

Missing expectations is the last thing you can afford to do when investors’ hopes are so high.

The average negative surprise is running at 5 per cent but that disguises some massive undershoots in the worst affected sectors of energy and mining, where numbers have come in more than a third below forecasts. But even in the parts of the economy which should be in the sweet spot of growth, consumer stocks, car makers and industrial companies are reporting 7-9 per cent below expectations.

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With the average stock in India trading on more than 23 times expected earnings, disappointing results are being hammered by investors. The average price fall on the day of a results announcement for a company that misses earnings is running at 4 per cent, twice the recent average. Nerves are particularly pronounced among foreign investors who are less emotionally attached to the market than their domestic counterparts. An index of the stocks favoured by overseas investors has fallen by 8 per cent over the past month, more than the overall market’s decline.

Appetite for newly listed shares has also taken a knock. Last month, investors turned their noses up at the world’s second biggest initial public offering (IPO) of the year - the Indian arm of Korean car maker Hyundai - with the retail slice of the share offering in Mumbai only half taken up. Investors decided that 26 times earnings was too steep a price to pay, even for a company tapping into the third largest car market in the world after the US and China. It felt like a watershed moment after a string of other IPOs this year had been massively oversubscribed.

If the Indian market has hit an air pocket, no-one can claim they weren’t warned of the dangers. One domestic brokerage said in the summer that shares were being buoyed on a wave of ‘rightful optimism and mistaken euphoria….based on unfounded narratives.’

The multiple of earnings at which shares trade is one measure of the punchy valuations in the Indian stock market. Another is a comparison of the value of the stock market and the size of India’s GDP. With economic output of around US$3.5trn, the US$5.5trn value of the market at the end of August looks to have shaky foundations. Also worrying has been the pace of growth. It took nearly four years for the size of the Indian stock market to grow from US$1trn to US$2trn but just six months for it to increase from US$4trn to US$5trn. At that level it is still dwarfed by the US stock market (worth over US$50trn) but fast catching up with Japan (US$6trn) and China (US$10trn).

The long run case for investing in India is compelling. The country’s economy is likely to become the world’s third largest as soon as 2027. It benefits from a massive demographic dividend compared to most countries in the world, with the proportion of its population in the 15-64 working age range continuing to rise until the 2050s. The middle class has been growing at over 6 per cent since 1995 and represents around a third of the population, a massive boost to consumer spending.

India’s economic development looks like China’s before Japanification set in several years ago. Manufacturing still accounts for less than 20 per cent of the economy and the government has laid out plans for goods exports to hit US$1trn a year by 2030. That will be enabled by infrastructure spending estimated at US$1.4trn over the next five years. Metro rail projects are underway in 21 cities. Over the past decade, 75 new airports have been built. A planned US$360bn of investment will see renewable energy capacity more than double in the next six years.

Which all creates a massive headache for investors. Should they focus on the world’s best growth story and pay whatever it takes for a seat at the table. Or should they wait for the world’s most expensive major market to re-enter the earth’s atmosphere and present a more sensible buying point. The change in sentiment in recent weeks feels like more than a pause for breath. If you are late to this party, it probably won’t hurt to see how the correction develops.

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Please note that the views expressed in this article are my own.

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