Why India Now?

India’s stock market has been on a tear over the last three years, up 46% compared to 20% in global equities and -13%  in emerging market equities. Only the U.S. has come close to performing this well over the same time period. This recent run has focused global attention on India, and has led some investors to wonder whether they have missed the opportunity. With headlines declaring India the world’s next growth engine or decrying the sharp run-up in markets, it can be challenging to cut through the noise. In today’s Asia Strategy Focus we address the key question facing investors: What’s driving the Indian market and can it continue?

India has rallied over the past year, but it’s important to note that this is not a recent phenomenon. In the 20 years prior to Covid, India outperformed the rest of the world, delivering an annualized 8.9% return. In fact, it’s the only market globally that comes close to matching the U.S. over the last 20 years, even in USD terms.

What about valuations? Is India an expensive market just driven by the surge of recent inflows?

Indian equity valuations are down from their 2021 highs. They are not attractive valuation-wise but they also do not appear euphoric at the moment. Many will point out that India is expensive relative to other emerging markets. While this is true, it is difficult to compare equity multiples directly on a country-by-country basis as the range of growth prospects, earnings clarity and household savings – among other variables – differ so broadly across EM economies. Ultimately the multiple is what investors are collectively willing to pay for a future stream of earnings; for countries with high future growth potential and a track record of impressive earnings, a higher multiple makes sense.

What about flows? Has India only benefited from global investors turning negative towards China?

This is where we see a disconnect between popular opinion and what the data is showing. India has indeed seen recent positive flows, but those flows still pale in comparison to flows into Chinese equities. Contrary to common narratives, China equity funds and exchange traded funds (ETFs) have not suffered outflows this year. According to available data on broad funds and ETF positioning, China has actually seen a surge of inflows this year, which is in fact one of the most significant movements of capital into any market since 2020. This follows a trend of very strong flows into China since 2020. Flows into Indian equity funds have been rising but on a much more gradual scale.

Comparing absolute flows does not necessarily give the most accurate picture, since China’s markets are much bigger and able to absorb more capital. But even looking at flows as a share of market cap, global flows into India have still slightly trailed China. What does this all mean? India isn’t simply a beneficiary of surging global inflows, nor is it a beneficiary of money flowing out of China. Indian equities have been rising consistently over years, driven by strong earnings growth.

With regards to China, there has not been a massive exodus of global capital, but rather – equities are down simply because the price investors are willing to pay for Chinese shares has come down (as evidenced by declining multiples).

Why is now a good time to invest into India?

It’s not so much a matter of now. India has been one of the best performing markets in the world over the last 20 years. We see it as a long-term allocation, and surprisingly a position that many investors do not have; amounting to less than 1% of equity allocation, below the benchmark allocation of 2-3%.

From a structural perspective, given India’s outlook (and track record) we think it makes sense to be at least ‘neutral’ relative to the benchmark, or even higher, as part of a strategic asset allocation.

We know ‘past performance is not a reliable indicator of future returns’. So what are the prospects for future returns?

When investing into any market, but especially emerging markets, two things matter. The first is overall economic growth. How fast an economy can grow, especially in nominal terms, matters because it affects corporate revenue growth (earnings) and the perception of future potential growth (multiples).

The second factor is how this overall economic growth translates to corporate earnings. It’s intuitive that earnings growth would track GDP growth, but the fact is that in many cases this isn’t true. Across most global markets this relationship holds true, however in emerging markets there is often a disconnect. It can stem from a number of issues – including lack of corporate profitability and inefficiency, or the market composition not reflecting the economy. However, most often it’s due to companies issuing shares and diluting shareholder value.

Earnings are measured on a per share basis (EPS). When companies are doing well but choose to issue more shares, EPS doesn’t rise. Without rising earnings, the only thing that can drive a market higher is valuation, which is not sustainable over the longer term.

Can India become the driver of global growth as China slows?

For decades, China has been regarded as one of the largest drivers of and contributors to global economic growth. Many are now looking to India to take on that role as China’s growth prospects dim in the midst of a challenging transition to a different economic model.

To be sure, at $3.5 trillion compared to $17.8 trillion, India’s GDP is still dwarfed by China’s. However, this sets up a tantalizing prospect – can India offer a similar growth runway to China in the late 20^th century? Following reforms in the late 1970s, China’s economy grew around 10% per year for three decades, attracting foreign capital and boosting growth as the economy transitioned from agriculture towards higher value-added manufacturing and services.

Proxied by GDP per capita, India’s current development level (~$7,000) matches that of China in the mid-2000s. India’s share of GDP in primary industries (mostly agriculture) sits at 17%; nearly double that of China (and matching China in the late-1990s). This gives India plenty of room to catch up to a more productive manufacturing-focused economy like China, as the country urbanizes and workers move from farm to factory.

Looking at economic growth, the difference in trajectory is clear. The IMF projects growth in India to remain strong at between 6.2% to 6.5% for the next five years (vs. 3.3%-4.6% for China), while Bloomberg Economics projects India to overtake China as the largest global growth driver as early as 2028 (and by 2037 in a pessimistic scenario). What are the key drivers of this shift in momentum?

1. Labor: India’s labor force underpins exciting prospects for manufacturing growth. According to Bloomberg, over 48 million medium-skilled workers, largely in the manufacturing sector, could retire from China and developed economies from 2020-2040, while India could add over 38 million such workers. This labor supply is a key input into the ongoing manufacturing boom, and is attractive to companies establishing manufacturing capacity in India. India’s current share of employment in primary industries still sits above 40% (around 236 million workers), down from around 70% forty years ago and similar to China in the mid-2000s. Continued growth in manufacturing can power the economy by lifting millions into higher value-added jobs, eventually also boosting domestic consumption.

3. Productivity and reform: The supportive labor and capital backdrop bodes well for India, but sustainable growth potential can only be realized through productivity enhancements via continued reforms. Education and skills training is a key area – workers need to be upgraded in order to facilitate their move from primary into secondary industry employment. Alongside infrastructure, urbanization also has room to improve (36% vs China’s 64%) – reflecting the challenge of efficiently and sustainably rehousing large numbers of rural workers. Cutting red tape and implementing incentive programs to stimulate manufacturing have been attractive to business investment and could continue.

India has many challenges to overcome before it can take on the mantle of global growth leadership, which will likely take time. However, with Prime Minister Modi’s party widely projected to win the upcoming national elections, continuity in his administration’s agenda of business reforms and productive investments could help pave the runway for India’s medium and long-term growth, not unlike China’s experience with its reform and growth story decades ago.

Nonetheless, growth does not equate to equity returns – at least not for most EM (as discussed above) – so has Indian growth translated to earnings?

India stands out as one of the very few markets where equity performance and GDP growth have a close relationship. Should the positive growth trajectory continue, its markets could continue to benefit. Over the long-term, corporates have steadily grown earnings and returned that value to shareholders. Shareholders have not suffered from the widespread poor governance, share dilution, or lack of profitability that plagued most of EM.

I don’t understand the market – what are the risks of losing money in Indian equities?

As with investing into any emerging market (or developed market, for that matter), there are risks of losses stemming from a lack of understanding of the market and its dynamics, or investing into poorly-managed or fraudulent companies. These could lead to underperformance or significant value destruction over time.

However, compared to other Asian markets over a long time horizon, India has impressed with a below average rate of companies experiencing catastrophic losses, negative absolute returns and negative returns against the index, while delivering some of the highest rates of large winners in the equity market. Statistically, that makes India one of the strongest performers among these markets, while highlighting the importance of active management.

Can the rally continue?

We remain convinced of the structural growth opportunity in Indian equities, underpinned by low-teens compounding earnings growth for the next several years. In this respect long-term investors could be at least ‘neutral’ relative to the benchmark, and a strategic ‘overweight’ is warranted in our view.

Looking more tactically, we are slightly above our YE24 Index outlook (2,500-2,630) and do expect the market to consolidate their impressive gains over the last 6 months. From December ’23 quarterly results, we see room for 1-2% upward revisions to our 2023 earnings estimates due to strength in the Consumer and Real Estate sectors, but await March quarterly results before re-assessing if earnings for 2024 need to be revised higher.

3-5% pullbacks in MSCI India are typically opportunities to add exposure. In March, we witnessed a pullback particularly in small/mid cap companies on the back of the Securities and Exchange Board of India (SEBI) commenting on excess in the space due to rapid inflows by domestic investors in 2023. However, we view the 20% valuation premium Indian mid-caps enjoy over large caps as largely justified by the higher earnings growth rate delivery of these companies, and don’t view valuations as excessive. Foreign ownership of Indian equities also remains low relative to history. With the Indian general election likely to run from 19 April – 1 June, short-term volatility typically picks up and could provide an opportunity to “buy-the-dip”.

All market and economic data as of April 11, 2024 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.

For illustrative purposes only. Estimates, forecasts and comparisons are as of the dates stated in the material.

There can be no assurance that any or all of these professionals will remain with the firm or that past performance or success of any such professional serves as an indicator of the portfolio’s success.

We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.

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Indices are not investment products and may not be considered for investment.

We are not recommending the use of benchmarks as a tool for performance analysis purposes.  The benchmarks used in this report are for your reference only.

For illustrative purposes only. This does not reflect the performance of any specific investment scenario and does not take into account various other factors which may impact actual performance.

Past performance is not a guarantee of future results.  It is not possible to invest directly in an index.

RISK CONSIDERATIONS 

• Past performance is not indicative of future results. You may not invest directly in an index. 
• The prices and rates of return are indicative as they may vary over time based on market conditions. 
• Additional risk considerations exist for all strategies. 
• The information provided herein is not intended as a recommendation of or an offer or solicitation to purchase or sell any investment product or service. 
• Opinions expressed herein may differ from the opinions expressed by other areas of J.P. Morgan. This material should not be regarded as investment research or a J.P. Morgan investment research report.

Index Definitions

The MSCI India Index is designed to measure the performance of the large and mid cap segments of the Indian market. With 136 constituents, the index covers approximately 85% of the Indian equity universe.

The MSCI China Index captures large and mid cap representation across China A shares, H shares, B shares, Red chips, P chips and foreign listings (e.g. ADRs). With 704 constituents, the index covers about 85% of this China equity universe. Currently

The MSCI AC Asia ex Japan Index captures large and mid cap representation across two of three Developed Markets countries (excluding Japan) and eight Emerging Markets countries in Asia. With 609 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country. Developed Markets countries in the index include: Hong Kong and Singapore. Emerging Markets countries include: China, India, Indonesia, Korea, Malaysia, the Philippines, Taiwan and Thailand.

Standard and Poor’s 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The index was developed with a base level of 10 for the 1941–43 base period.

The EURO STOXX 50 Index, Europe's leading blue-chip index for the Eurozone, provides a blue-chip representation of supersector leaders in the region. The index covers 50 stocks from 11 Eurozone countries.

TOPIX also known as the Tokyo Stock Price Index, is a capitalization-weighted index of all companies listed on the First Section of the Tokyo Stock Exchange.

The Bovespa Index, best known as Ibovespa is the benchmark index of about 86 stocks traded on the B3, accounting for the majority of trading and market capitalization in the Brazilian stock market. It is a weighted measurement index.

Hang Seng Index: is a free float-adjusted market-capitalization-weighted stock-market index in Hong Kong. It is used to record and monitor daily changes of the largest companies of the Hong Kong stock market and is the main indicator of the overall market performance in Hong Kong.

The BSE SENSEX is a free-float market-weighted stock market index of 30 well-established and financially sound companies listed on the Bombay Stock Exchange.

The Jakarta Composite Index is a modified capitalization-weighted index of all stocks listed on the regular board of the Indonesia Stock Exchange.

The FTSE Bursa Malaysia Index comprises of the largest 30 companies by full market capitalization on Bursa Malaysia's Main Board.

The S&P/BMV IPC Index seeks to measure the performance of the largest and most liquid stocks listed on the Bolsa Mexicana de Valores.

The Straits Times Index (STI) is a market capitalisation weighted index that tracks the performance of the top 30 companies listed on SGX.

The FTSE/JSE Top 40 Index consists of the largest 40 companies ranked by investable market value in the FTSE/JSE All-Share Index.

The Korea Composite Stock Price Index or KOSPI is the index of all common stocks traded on the Stock Market Division—previously, Korea Stock Exchange—of the Korea Exchange.

The TWSE, or TAIEX, Index is capitalization-weighted index of all listed common shares traded on the Taiwan Stock Exchange. The index has a base value of 100 based on its 1966 level. The index is also known as the TSEC Index.