Indian Stock Market Declines Due To Global Risk Aversion But Fundamentals Remain Strong

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Includes: EPI, IBN, INDY, SCIN, VEDL
by: Sneha Shah

Summary

The Indian stock market has fallen mainly due to global risk aversion, however quantum of fall is much lower than other major emerging markets.

Structural economic reforms continue to be implemented though at a slow pace.

Valuation of Indian stock market has become more attractive, with some sectors trading at very cheap valuations.

The Indian stock market has fallen around ~16% from its peak level reached last year mainly due to global macro weakness, as concerns about the Chinese slowdown and falling oil prices have led to risk aversion amongst investors. Though the Indian stock has declined, the quantum of the fall has been much lower than that of other emerging stock markets such as China, Brazil, Russia, Malaysia and others.

Foreign institutional investor selling has been compensated by increasing inflows of domestic money, which has prevented a sharper fall in the indices. Though sentiment has weakened, fundamentals have not deteriorated to warrant such a fall. Falling crude oil prices are a boon for the Indian economy, as it is estimated that a $1 fall in oil prices leads to a $1 billion gain for the Indian economy.

The commodity price fall has been a net positive for the Indian economy. Though the Indian steel and metal industry along with some oil companies such as Cairn India, ONGC have been hurt, other companies have gained due to falling input prices. The margins of Indian companies have improved with cement, paint, consumption, refinery and fertilizer companies benefiting.

The Indian government is also making important economical reforms, which should lead to a higher growth trajectory in the medium to long term. Investors and industrialists have realized that the Indian economy represents the only major global economy, with strong growth prospects and are starting to make big investments. The economy, which is growing at 7% plus levels should show similar growth rates in the future as well.

Why you should buy Indian stocks

1) The stock market has become cheaper after the correction - The stock market has become cheaper after the recent fall. Some of the froth in the mid-cap and small-cap space has been washed away, after many stocks fell by 30-40% in the last few months. Many of these stocks had shown an increase of more than 100%, as retail investors had piled into these companies due to the Indian growth story.

Some of the valuations were unsustainable, as the stocks had run up too much too fast. The large-cap space is also looking much more reasonable, with some capital goods, banking and metal stocks looking extremely attractive. Note the Indian stock market P/E has fallen to around ~18x, from around ~21x. Though still at a significant premium to the MSCI Index, this has increased the margin of safety for investing in the Indian stock market.

2) Foreign investment is increasing - The new government led by PM Modi has intensely courted foreign investors and leaders. Numerous visits to foreign countries to invite foreign investments is bearing fruit, with many companies looking at India as their main growth engine in the coming years. Apple's (NASDAQ:AAPL) CEO Tim Cook said in this most recent conference call that Indian sales have increased sharply compared to the slowing growth in the Chinese market.

Chinese companies are looking to bulk up their investments in India, with China's largest property group Wanda planning to build a $10 billion park in India. Japan has already committed to invest a huge amount of money to run bullet trains between Mumbai and Ahmedabad. The "Make in India" policy is starting to show results with investments increasing.

3) Structural reforms are being implemented at a steady continuous pace - While many critics have panned the Indian government for being too slow in implementing reforms in the country, it is to be remembered that India is a democracy where decision-making has been slow. It is not easy to bulldoze reforms in India, unlike China where local protests can be suppressed by the iron hand of The Communist party. That said, important reforms are steadily taking place, which should help India sustain a high growth trajectory. The recent Start up policy has made it easier to start a business in India, with a number of incentives being given for startups such as a 3-year tax holiday and reduction in red tape for registering and operating businesses.

Where to invest

While the Indian stock market indices have fallen slightly, some sectors such as mining, capital goods and state-owned banks have taken a massive haircut over the last one year falling by 50-80%. Some of the companies have become extremely cheap, with most of their market capitalization accounted by cash on their balance sheet. While I would not recommend some of the indebted companies such as Vedanta (NYSE:VEDL) as a sure shot buying opportunity, others such as NMDC, Cairn India, MOIL etc. look attractive from the valuation viewpoint.

They have low cost of operations and are cash rich. They will also benefit as their home market continues to grow at a fast clip. Capital goods companies such as L&T also present a good option, considering its strong pedigree and fallen stock price. State owned banks have also declined sharply, with their P/B touching levels as low as 0.2x. These banks should not go bankrupt, as they are owned by the government and when the economy recovers they could give a good return. However, they have a higher risk from equity dilution, if the government has to recapitalize them in the future.

Some of the ETFs that you could look to invest to take advantage are:

1. Wisdom Tree India Earnings ETF (NYSEARCA:EPI)

2. iShares S&P India Nifty Fifty Index ETF (NASDAQ:INDY)

3. PowerShares India Portfolio ETF (NYSEARCA:PIN)

4. EGShares India Small Cap ETF (NYSEARCA:SCIN)

Risks

a) Increasing Non-performing loans at state owned banks - The gross non-performing loan ratio for most state owned banks has increased sharply over the last couple of years, with some banks reporting a gross NPA at more than 10%. This has led to a steep fall in the stock prices of all state owned banks such as State Bank of India, Bank of Baroda, Punjab National Bank and others. They are trading at all-time low valuations, as investors think that they will have to be recapitalized as bad debt is too high for most of them.

Even some of the larger private banks such as ICICI Bank (NYSE:IBN) and Axis bank which have exposure to the corporate sector, have fallen sharply in the last couple of months on asset quality concerns. Credit growth by these banks have also slowed down, as they grapple with increasing bad debt on their balance sheets.

b) Global macro weakness - The biggest risk to the Indian stock market is the slowing down of the world economy. Trade has already fallen in the last one year, as both exports and imports have declined. Falling emerging market assets are also affecting the Indian stock market, which is falling, as its relative valuation to other assets become too high. If the Chinese economy goes through a hard landing, then the Indian stock market may not come out unscathed as foreign investors rush for the exit.

Conclusion

Despite the recent stock market decline, Indian stocks remain the best bet in the emerging market asset universe given the political stability, strong growth prospects and relative lack of exposure to the Chinese economy. The Indian economy also benefits strongly from falling oil, coal and edible oil prices as it imports billions of dollars of these commodities every year. Inflation and interest rates have also fallen to the low single-digit level, due to good monetary management by the Indian central bank.

Given the current global scenario, one cannot be certain that the Indian stock markets will not fall more. However, given the fundamentals, falling prices are a good opportunity to load up on Indian stocks, which had run up in the last couple of years. Some areas have become cheap, given the sharp decline in the last couple of months. Some blue chip stocks have also become reasonably cheap now and should give good returns in the medium to long term.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I hold mutual fund units in the country that might invest in these stocks.

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