Indian Equities.. Riding the Up-Escalator

With uncertainty currently dominating the news, many investors are probably wondering what they should do next. With the benefit of hindsight, the answer to that question is usually “invest”. We all tell ourselves that we want to buy low and sell high but in practice, few of us have been able to do so. It is all too easy to wait until there isn’t a dark cloud in the sky and shares have recovered to comforting new highs but by then it is all too often, too late. It is interesting to see that household name investors such as Warren Buffett are buying equities at prices that he has described as “on sale”.

Indian equities have performed poorly this year as investors have become risk averse. This is hardly a new phenomenon. During the last decade there have been four occasions when the Indian stock market has fallen by more than 20 per cent. As scary as these occasions must have felt at the time, brave investors were handsomely rewarded with the average return over the next two years being an astonishing 120 per cent.

Few would doubt that India has some powerful advantages. I would describe investing in such vibrant economies as “riding the up-escalator”. We believe that this metaphor contrasts with the difficulties that will be faced in the west where companies are going to be “running up the down escalator” for many years to come. Of course, there will be companies that prosper in the west just as there will be those who fail in India despite the obvious advantages surrounding them. However, on balance, we would rather invest in companies that are being carried along by strong growth trends rather than having to fight against headwinds. Yes, there have been some profit downgrades in India in recent months but that still leaves forecast earnings growth of circa 25 per cent in 2012 and 18 per cent in 2013!

Indeed, if anything, India’s growth rate has actually been accelerating over the last half century. During the 1950’s, 60’s and 70’s, the Indian economy grew by more than respectable four per cent or so each year. During the 80’s and 90’s this growth surged to more than five per cent and over the last decade it has hit a different gear, regularly topping eight per cent per annum. To put this into context, between 2008 and 2011, India enjoyed GDP growth of almost 50 per cent. During the same period the US, Europe and Japan limped from one recession to another. So strong has this growth been that India has suffered a dose of inflation. The Reserve Bank of India should be credited for moving swiftly to contain this with 11 rate increases that now appear to be succeeding in cooling the economy. Stock market historians will know that the end of the rate cycle is often a great time for investors to begin accumulating shares.

There are compelling reasons to believe that the gap between India and the rest of the world will continue to expand exponentially. At the most basic level, economic growth can come from either an expanding population producing and consuming more goods or a static population consuming ever more goods (or a bit of both). The west, has collectively decided to borrow vast sums to allow themselves to consume in the past at the expense of consuming in the future. They have bought houses, cars, holidays, etc. and now need to pay for them. This will mean that they need to buy less in the future. Firstly, because they already own things (and therefore don’t need to buy them again) and secondly, because they must repay their debts. This bodes ill for companies that want to sell things to western consumers in the future.

In India, the situation is night-and-day different. India has a population of well over a billion people already, most of whom have a long list of things that they don’t yet own- mobile phones, fridges, cars, televisions, etc. This provides Indian companies with a massive marketplace for decades to come. Maruti Suzuki were selling 120,000 cars per annum in 2004. Today, they are selling more than this every month and still have huge order backlogs. The situation is similar at Honda Hero (after split known as Hero Motocorp) which has gone from selling 500,000 bikes per year to more than 500,000 per month. Also, this population is growing by around 10 million people each year. The average age of India’s population is just 25 with decades of consuming and saving ahead of them. Compare this with most western economies (and even China) which are turning grey. If a company can just keep pace with such population growth, this will give them more than enough growth opportunities without needing to expand market share or innovate. It’s that “riding the up-escalator” phenomenon again. Such earnings growth has created some genuinely massive winners already. Jindal, a steel and power company has seen a hundred-fold growth in its market capitalisation.

All of this is helped by the fact that India carries much lower debt levels than the west and therefore more money can be driven into consumption and investment rather than debt repayment. The plight of western government debt has dominated the headlines in recent weeks. In contrast, the Indian government has pledged to spend $1.3 trillion over the next seven years on infrastructure. Great news and terrific cash flow visibility for companies supplying cement, cables, excavators and a multitude of over goods and services. Infrastructure stocks such as Larsen & Toubro have already seen two hundred fold growth in their value but there is every reason to believe that there is more to come.

Accessing this growth has historically been difficult for many UAE based investors. It is practically impossible for non-NRIs to buy Indian shares directly. Even for NRIs, buying shares directly will be burdensome. You will have to set up brokerage accounts, research companies that you wish to buy and then follow the news flow from your chosen companies to identify the right time to sell. For busy people with full time jobs or families, this can be very difficult and most investors eventually come to the view that they should hand over the day to day responsibility to a professional fund manager. Such managers have access to meet with company CEOs and CFOs to get a deep understanding of the likely prospects. They will also have teams of economists, strategists and technical analysts who can help them make better decisions.

Indian equities have very good value in our opinion and are trading at levels which have historically proven to be good entry points. With so much uncertainty around, it is impossible to say that we have reached the bottom of the Indian stock market and for this reason we are currently suggesting that our clients consider investing on a regular savings basis into a top quality Indian fund of fund such as NBAD India. Such a strategy will allow an investor to buy cheap units today and still buy them more cheaply if the market has a further set back. By investing all along the bottom of a U shaped market, you can enjoy strong growth when markets recover.

There is another compelling reason to invest in the Indian market, which is loss in the value of its currency. Worsening global outlook, and the consequent risk aversion for emerging markets, has reduced the FII inflow into India, thereby the supply of US dollars in the country. This, along with other reasons like rising current account deficit, inflation, etc., led to a fall in the INR to its lowest level since May 2009. In our opinion, interest rates and growth differentials, the Reserve Bank of India’s efforts to control inflation and increase in the FII inflow will result in appreciation of the rupee over time.

Unless you believe that there are reasons why the Indian economic juggernaut will go into reverse or hope that the west’s problems will melt away, we passionately believe that every investor who is focused on growing their wealth over the years ahead should have an allocation to this still emerging growth story. You will usually have to quite rightly pay a high price for this growth but today, these perfectly good companies are on the sale shelf. We do not believe that they will be there for long.