Equity markets in the Indian subcontinent are likely to benefit from positive market sentiment this week as a six-week long election comes to an end, confirming incumbent Prime Minister Narendra Modi’s third term in office.
However, against the backdrop of significant economic reform and likely policy continuity from the Modi government, investment managers pinpoint India’s expensive valuations as a roadblock to their allocations.
Elaborating on the Indian growth story, Anh Lu, lead portfolio manager for the Asia ex-Japan Equity Strategy at T. Rowe Price, identified India’s burgeoning population, dynamic and youthful workforce, and advancements in technology as key factors that will shape its economic and social landscape.
“India’s stock market over recent years has followed the trajectory of its economy and has been one of Asia’s best-performing stock markets. We think the country’s prospects are bright,” she said.
However, “the challenge for us as investment professionals is centred largely around valuations”, she said, with investors currently willing to pay a premium for Indian companies.
“With India’s economy recovering strongly after COVID, the best performing part of the stock market has been in the more cyclical areas, particularly in the small- and mid-cap space, where retail investor inflows have pushed the valuations of many stocks to record highs,” she said.
In uncovering opportunities less appreciated by the stock market, Lu outlined the appeal of the banking sector.
“Within the context of India being an expensive market, we find the most attractive opportunities today in blue chips, notably the banks. These companies offer durable earnings growth potential and are trading on reasonable valuations, having been somewhat overlooked by the market,” she said.
Speaking to InvestorDaily, Ox Capital’s chief investment officer, Dr Joseph Lai, also turned to India’s banks as an area of promise.
“Within equity markets, the banking sector still offers significant growth,” he said.
However, valuations still pose a headwind, given they are presently expensive relative to historic levels and other emerging markets, he conceded.
For Chris Clube, co-portfolio manager of the Federated Hermes Global Emerging Markets Equity Fund, the issues largely stem from the fact that India’s economic growth story is no longer a secret.
“Absolutely everyone knows about how great the economic growth story of India is, both externally and internally. And when you have such a consensus around a great outlook, and the outlook is so great that people can’t even see any potential pitfalls, you do start to see some hyped-up valuations,” he observed.
“You start to see, I think, some behaviour in the markets which is slightly concerning in terms of people being overoptimistic and overpaying for the opportunity set. And this is what we find again and again when we look at India on a stock-by-stock basis, particularly in the small and mid-cap space. We find companies whose valuations we simply can’t justify. We love the business, we love the outlook, but we can’t understand how people have managed to convince themselves that this is a great stock purchase opportunity.”
As a result, the fund is currently sitting a little bit underweight India today, while it continues to keep an eye out for any pullback, he said.
“We have companies in the portfolio that we’re very happy with that aren’t trading at these very overhyped valuations and don’t over discount the opportunity set. But there is a long list of companies we would like to buy that are simply too expensive for us today. So, our pencils are sharpened, we have a stack of ideas in our inventory that we’d love to be able to buy, and we’re ready if and when there’s a pullback,” Clube told InvestorDaily.
“This isn’t a prediction – we can’t tell what will happen over the next 12 to 18 months with Indian equities, but if and when there’s a pullback, we’ll be ready to load up in India because we’re as excited about the opportunity set there as anyone else.”
