Global Investing

Indian shares: disappointment may lurk

Should Indian shares really be at record highs?

The index is up 3.6 percent this year. Foreign funds have been pouring money into Mumbai shares, betting that the opposition BJP, seen as more reform-friendly than the incumbent Congress, will form the next government. They purchased $420 million worth of Indian stocks last Friday, having bought $1.4 billion over the past 15 trading sessions.

There is also the fact that the rolling crisis in emerging markets, having smacked India during its first round last May, has now moved on and is ravaging places such as Russia and Nigeria instead. The rupee has firmed almost 2 percent this year to the dollar, as last year’s 6.5 percent/GDP current account deficit has contracted to just 0.9 percent of GDP.  Many international funds such as Blackrock and JPMorgan Asset Management have Indian stocks on overweight and Bank of America/Merrill Lynch’s monthly survey showed investors’  underweight on India was one of the smallest for emerging markets.

Indian company earnings may have beaten forecasts by around 5 percent so far in the season. But prospects can hardly be described as attractive. Indian economic growth is running at less than 5 percent. Valuations are in line with historical averages and at a 4 percent premium to global emerging markets on a book-value basis. But John-Paul Smith at Deutsche Bank says it is “the least bad” of the BRICs and is neutral to overweight.

You can see why money is going there, most of GEM looks grim. The question is to what extent a big win for the BJP is factored in. They seem to be moving towards the ability to put together a workable coalition but the outline of their economic policy is not clear. The other story of India is governments can pass laws but implementation is quite different.

Morgan Stanley analysts note that Value-at-risk (VaR), a measure of the level, timing and probability of risk, for the Indian stock market is close to record lows while the recent gains have driven price-earnings ratios to 3 year highs. What this means is India is perceived as “a safe haven in a rocky emerging world”, they write:

Lower rates give no respite to Brazil stocks

In normal times, an aggressive central bank campaign to cut interest rates would provide fodder for stock market bulls. That’s not happening in Brazil. Its interest rate, the Selic, has fallen 350 basis points since last August and is likely to fall further at this week’s meeting to a record low of 8.5 percent. Yet the Sao Paulo stock market is among the world’s worst performers this year, with losses of around 4 percent. That’s better than fellow BRIC Russia but far worse than India and China.

Brazil’s central bank and government are understandably worried about a Chinese growth slowdown that would eat into Brazilian commodity exports. They are therefore hoping that rate cuts will prepare the domestic economy to take up the slack.

But the haste to cut interest rates appears to have spooked some foreign investors, with many seeing the moves as evidence of political pressure on the central bank. A closely-watched survey from Bank of America/Merill Lynch showed that fund managers had swung into a net 14 percent underweight on Brazil in May from a net overweight of over 20 percent in April (See graphic). This is the first time investors have turned negative on Brazil since February 2011, BofA/ML said.

In defence of co-investing with the state

It’s hard to avoid state-run companies if you are investing in emerging markets — after all they make up a third of the main EM equity index, run by MSCI. But should one be avoiding shares in these firms?

Absolutely yes, says John-Paul Smith at Deutsche Bank. Smith sees state influence as the biggest factor dragging down emerging equity performance in the longer term. They will underperform, he says, not just because governments run companies such as Gazprom or the State Bank of India in their own interests (rather than to benefit shareholders)  but also because of their habit of interfering in the broader economy.  Shares in state-owned companies performed well during the crisis, Smith acknowledges, but attributes emerging markets’ underperformance since mid-2010 to fears over the state’s increasing influence in developing economies. (t

Jonathan Garner at Morgan Stanley has a diametrically opposing view, favouring what he calls “co-investing with the state”.  Garner estimates a basket of 122 MSCI-listed companies that were over 30 percent state-owned outperformed the emerging markets index by 260 percent since 2001 and by 33 percent after the 2008 financial crisis on a weighted average basis. The outperformance persisted even when adjusted for sectors, he says (state-run companies tend to be predominantly in the commodity sector).