India’s stock markets are expected to power on if Narendra Modi wins a third electoral victory this year, even as investors grow fearful that the index gains are built on stretched valuations.
The country’s enviable economic performance, which has underpinned strong corporate earnings, and political stability under the prime minister are fuelling bullish sentiment among investors, with the IMF forecasting India will grow at 6.5 per cent this year and next.
The BSE Sensex index hit a record high this month, having risen every year since 2016, while the total value of its equity market has now eclipsed Hong Kong. Some analysts see no reason why years of market gains should not continue.
“India has the best long-term growth prospects in the region, the corporate sector has demonstrated an ability to translate strong economic growth into earnings and stock market returns,” said Sunil Koul, Asia-Pacific equity strategist at Goldman Sachs.
But after years of gains, some analysts are growing cautious about the lofty valuations. Among large-caps, a flood of new money is pushing up the share prices of companies with very low free-floats. Meanwhile, regulators are clamping down on trading in smaller stocks, with some drawing parallels with the US’s 2021 meme stock craze.
For now few see clouds on the horizon. Modi, India’s most popular leader in decades, is widely expected to cement a third term in power following national elections being held between April and June.
Many investors have welcomed the prospect of political stability they believe another Modi term brings. Political opposition is in disarray. The Indian National Congress, the biggest block contesting Modi’s ruling Bharatiya Janata Party, complained it has been unable to campaign after its bank accounts were frozen this month while another prominent leader was arrested.
Modi’s government is ushering in manufacturing investment as companies seek to diversify supply chains outside of China, while India’s physical and digital infrastructure has also improved. New Delhi has also benefited from the continued import of cheap Russian crude without sanctions thanks to its courtship of western governments.
The MSCI India index has advanced 141 per cent in the years since Modi was elected prime minister in 2014, dwarfing the 9.4 per cent climb of the MSCI Emerging Market index in the same period. Most of the gains have come in the years after the coronavirus pandemic hit financial markets. Goldman expects a 15 per cent compound annual growth rate for Indian earnings through 2025 that “should drive markets higher”.
Analysts said there was likely to be further inflow of money into India’s equity market from domestic pension funds and overseas investors.
Aditya Suresh, head of India equity research at Macquarie Capital, pointed out overall membership of Indian pension funds had climbed nearly 10-fold in the past five years.
“While a third term for the current government is already priced into expectations, after a formal result we expect to see incremental foreign institutional investor inflows,” he said.
But for all the excitement over India’s long-term economic performance, investors are growing nervous about whether the stock market rally is sustainable.
The MSCI India is trading at a forward price-to-earnings multiple for 2024 of 23 times, compared with 12.5 times for the broader emerging market index.
Earlier this month investment bank Jefferies held its annual Asia forum in Hong Kong. Following conversations with foreign portfolio investors, their analysts wrote that many fund managers “continue to grapple” with a market at “high multiples”.
Kamil Dimmich, a partner at London-based North of South Capital, said his emerging markets fund has not held Indian stocks for about two years following the “insane jump” after the coronavirus pandemic.
India “is not as liquid as one might think for such a big country . . . free-floats tend to be quite limited because you have these promoters”, he said, referring to India’s controlling founders and families.
“So when you get big, big foreign and domestic retail inflows it can drive the market up and of course that has resulted in this very high premium level,” he added.
India’s market regulator also stepped in to calm heated activity in smaller stocks, after both the S&P BSE small-cap and mid-cap indices rose 60 per cent in the past year.
The Securities and Exchange Board of India in late February requested Indian mutual funds find ways to slow the flow of funds into smaller stocks and protect investors from a wave of redemptions, sparking a sell-off and prompting concerns over a market downturn.
“The kind of best comparison would be the meme stocks and GameStop . . . it’s just retail-buying frenzies,” said Dimmich, who added that any deeper disappointments in India’s rosy economic picture or an adverse election result for Modi could result in a wider and protracted market underperformance.
“There’s no real valuation arguments to push the market,” he said. “It has to be driven by growth, growth, lots of growth and that’s always a little bit scary when your base case is the blue sky case.”
The clampdown has begun to cool enthusiasm at the smaller end of the market. The S&P BSE small-cap index is down 4.9 per cent month to date.
Shrikant Chouhan, head of equity research at Kotak Securities in Mumbai, said investors’ focus will now “start shifting into large-cap companies”. The benchmark Nifty 50, which covers India’s largest stocks, may hit 25,000 — or a 13 per cent upside from current levels — in the next 12 to 18 months, he said, even though it had risen 235 per cent over the past decade.
Even if India is hit by short-term shocks, few other markets offer the same multi-decade structural growth stories, according to Siddharth Mehta, founder and chief investment officer at Bay Capital, a London-based fund focused on Indian equities.
“The pace of change, the pace of flow may ebb and change, but the direction of travel is pretty obvious,” he said. “As a result of that there is a premium to come to India and I think the premium is justified in my opinion, I don’t see that narrowing anytime soon.”