I have maintained for years that India is an attractive investment destination for long-term investors. If policies remain conducive and the government stable, India still has the potential to deliver GDP growth that nears double digits.
Favorable demographics, rapid urbanization and rise of the middle-class (driving consumption spending) are some of the headline long-term factors that can trigger sustained growth for the Indian economy.
However, my focus for this article is relatively short-term and with the world's largest democracy voting for the next leader, the markets can be relatively volatile in the near-term.
In sync with this view, I believe that investors should remain in the sidelines for the next quarter, before considering fresh exposure to Indian equities. I also believe that investors who are sitting on unrealized gains should book profit before the General Election results are declared on May 23, 2019. This article will discuss some of the key factors to remain in the sidelines.
Election Result Scenario and Market Reaction
The ruling party in India is currently the Bharatiya Janata Party, which won a majority in the 2014 elections. The first scenario is that the ruling party wins an absolute majority in 2019 as well.
The probability of this outcome is relatively low as demonetization and a relatively complex goods and services tax introduction has been unpopular with the businesses. In particular, small and medium enterprises have been negatively impacted.
However, if the ruling party gains absolute majority, the markets are likely to trend higher. The reason is that markets like a single party in power than a coalition government, which makes policy decision making slow.
A second scenario is that the Bharatiya Janata Party forms the next government with the help of other smaller regional parties in India. The probability of this outcome is high. In terms of market reaction, there could be a downside of 10% to 15% as it limits the decision making power of the ruling government.
A third scenario is that the ruling party loses and a coalition government is formed with several parties in the opposition. This is the worst case scenario and cannot be ruled out in there is a significant anti-incumbency wave. The problem with this scenario is that the new government will have a different set of policies and the markets will take time to adjust to new policies. In addition, a coalition will always have challenges in terms of swift decision making.
Overall, election 2019 is among the most uncertain elections in India in terms of predicting the outcome. It therefore makes sense to remain in the sidelines than experience high degree of market volatility in the coming months.
Markets Not in Sync With the Economy
It is worth noting that the Indian markets are trading near all-time highs. One of the key reasons for this optimism is a speculative upside that the ruling party will come back to power. While the markets can trend higher for a very short-term if the ruling party wins, I expect the markets to trend lower in the next 2-3 months.
The reason is that the markets are not in sync with India's economic growth. The following points back my view -
- Automobile sales in India have plunged to its lowest since 2014 and this is an indication of weakening economic activity and consumer confidence
- According to the Centre for Monitoring Indian Economy, India's unemployment rate is the highest since 2016. According to another report, India's unemployment is the worst in 45 years. While the government has rejected the second report, it is clear that the economy is in a short-term downside.
- India's finance ministry report has acknowledged that the economy has slowed down in 2018-19 with declining growth in private consumption and weak exports.
With these data on the economy, there is little doubt that India is in a near-term downturn from an economic perspective and I expect the markets to trend lower once the focus shifts away from the election and the potential winner. It therefore makes sense to stay in the sidelines as market downside can be relatively sharp as economic reality is discounted by the markets.
While I remain bearish on the markets for the near-term, I remain bullish on India for the next 5-10 years. Therefore, it my view, it makes sense to consider exposure to fundamentally strong stocks on any broad market decline.
There are few Indian stocks listed in the United States stock exchange and I recommend the following stocks on any sharp market correction -
Tata Motors (TTM) - Tata Motors is in the automobile sector and has Indian as well as global operations. The stock has declined by 55% since the beginning of 2018 and I believe that the stock is attractively priced for gradual exposure over the next 2-3 months. Besides decline in auto sales in India, Tata Motors has been negatively impacted by decline in Jaguar Land Rover. However, I believe that the stock is attractive for exposure at current TTM price earnings ratio of 7.8. If there is resolution on trade wars and global economic activity trends higher, the stock is likely to be a value creator in the coming years.
HDFC Bank (HDB) - The Indian banking sector has been under stress with rising nonperforming assets. In particular, public sector banks have been negatively impacted. HDFC Bank, which is a private sector bank, is an exception. The bank has an excellent asset profile and this is reflected in the fact the HDFC Bank is currently trading at all-time highs. Just to put things into perspective, the gross nonperforming asset for the bank was 1.38% as of December 2018. This is at a time when the public sector banks in India have nonperforming assets even at 15% to 20%. Therefore, I believe that correction in broad markets can be a good opportunity to consider exposure to the bank with a long-term investment perspective.
The next few months for the Indian markets are likely to be characterized by high degree of volatility with a downside bias. While long-term fundamentals still remain in place, investors are better-off being underweight on Indian equities in the near-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.