Indian market ‘a victim of its own success’

Indian stocks have been among the world's worst performers since the start of the year, a victim of investors' fears that some emerging markets may be in for a period of slower growth.

The Bombay Stock Exchange Sensex Index tumbled to close on Monday at 18,307 points, down about 14 per cent from a record high of 21,005 last November. Concerns about rising interest rates, corruption scandals and climbing oil prices have prompted many foreign money managers to look elsewhere.

The decline in the Indian stock market is part of a wider shift out of emerging markets. Over the past four months, Indian, Brazilian and Chinese stocks have lagged behind stocks in the developed world as rising food prices and mounting pressures for higher wages fuel worries that these countries will have to raise interest rates to restrain inflation, a move that could put the brakes on their economic growth.

"The main factor hurting emerging market equities appears to be concern over inflation – or, more precisely, the prospect of monetary policy tightening that might be required to deal with rising inflation," UBS investment strategists Brian Rose and Stephen Freedman wrote in a report Monday.

Despite the recent selloff, the strategists remain fans of emerging market stocks in general and believe they will outperform over the next 12 months. They calculate that emerging market stocks trade at only 11.5 times forward earnings compared with 12 times in developed markets.

Strong Growth, Inflation

India's recent underperformance may be simply a reaction to recent euphoria over the country's prospects. In 2010, the Sensex index rose more than 17 per cent. "India is a victim of its own success," said Michael Penn, chief global equity strategist at Merrill Lynch in New York. "It had very strong economic growth last year, but the result has meant that inflation has become a concern."

Most India watchers remain bullish on the country over the longer haul, but suggest that investors may feel more pain over the near term. Suresh Mahadevan, head of Indian equities at UBS Securities, last week suggested that the market could decline an additional 10 to 15 per cent as foreign investors pull their money out of the market.

Mr. Penn agrees it will be tough to make money in India this year. "India is likely to remain in a trading range," he said. "You have economic growth slowing. It was 8.5 per cent last year, and our forecast is 8 per cent this year. It is still high, and is one of the highest growth rates of any market, but nevertheless, it is slowing."

Arthur Budaghyan, managing editor for emerging markets strategy at BCA Research in Montreal, expressed similar caution. He expects that India's galloping inflation rate of just over 8 per cent will not abate soon. "You would need to see food prices dropping, and that is not on the horizon so far," he said. "In the long-run, we are bullish, but it is not time to enter [this market]."

The Indian market is still pricey despite its slide, said Eric Yan, a portfolio manager with Toronto-based Matrix Fund Management Inc. "It now trades at 15 times forward earnings so it is still expensive compared to the average of 13 times in the overall Asian market, including China, Japan and South Korea. In China, the PE is at 11 times forward earnings."

Mr. Yan, who has scaled back Indian holdings in his Mavrix Asia Pacific fund, doesn't expect a turnaround soon. He points out that China is growing at 10 per cent a year and has only 4.6-per-cent inflation. The combination of faster growth and lower inflation is making China more attractive than India for many foreign investors, he said.

In addition, he said, growing optimism about a global recovery is luring money out of emerging markets. "With the U.S. economy recovering, some money will flow back to the developed markets."

Finding the Bottom

Ajay Argal, head of offshore equities with Birla Sun Life AMC Ltd. in Mumbai, said he believes that a major part of the correction in the Indian market is over, but expects "volatility will continue." He expects the Indian market will have a positive return this year, but doesn't expect it to be significant.

"Whether the bottom is now or in six months is not important," said Mr. Argal, who runs the Excel India Fund sold in Canada. "The important point is whether you are keeping your money in Indian for three, five or 10 years, or you want to just keep it in for six months and make a quick buck. … When you are investing in Indian equity or emerging markets, you need to have a long-term view."

Buying opportunities

Whether you see India as a buying opportunity now or later, there are several ways for Canadian investors to get a piece of the market.

Mutual Funds

Excel India has been around for more than a decade, while HSBC Indian Equity, Standard Life India Equity Focus and PowerShares India Class were launched more recently. PowerShares India Class invests in the PowerShares India Portfolio exchange-traded fund (ETF) listed on the New York Stock Exchange.

Closed-end fund

DPF India Opportunities Fund has been run since 2007 by veteran manager Rohit Sehgal of Goodman & Co. Investment Co. Ltd. The fund trades at about an 18-per-cent discount to its net asset value.

Canadian-listed ETFs

BMO India Equity Hedged CAD ETF (ZID-TSX) is invested in depositary receipts listed on U.S. and British stock exchanges. Nearly 50 per cent is invested in financial and information technology stocks. The iShares S&P CNX Nifty India ETF (XID-TSX) invests in the New York-listed iShare ETF of the same name, and tracks the S&P CNX Nifty Index of the 50 largest companies on the National Stock Exchange of India.

Shirley Won

How India funds have fared to Jan. 31, 2011