Indian stocks rebound over 3% after plunge

The Indian stock market, which is sought after by global funds, experienced a massive shock on Tuesday, recording its largest drop in four years, with a one-time decline of 8%. On Wednesday, the market rebounded, with the Indian SENSEX index rebounding by more than 3%, but the aftershocks were not over, and investors' concerns about the high valuation of the Indian stock market still exist.

Indian Prime Minister Narendra Modi announced his victory in the general election on Tuesday, but his support rate was unexpectedly lower than expected. Analysts pointed out that this made people doubt whether the new government has the ability to promote land and labor law reforms. "No one expected this result, everyone was surprised, and the Indian stock market has always been 'expensive'. A short-term sharp decline is indeed inevitable," the chief editor of the capital market of a leading Indian business media told the First Financial reporter.

Overall, international investors are not pessimistic about the prospects of the Indian stock market, the key is that the price is too expensive. Haresh Sharma, the institutional portfolio manager of Franklin Templeton's emerging market equity team, told reporters that India's share of global GDP increased from 1.1% in 1993 to nearly 3.5%. The performance of the Indian stock market is strongly correlated with economic growth, and this correlation is one of the highest among emerging markets. It is expected that the increase in income and the young population will drive consumption, and the structural reforms implemented in the past decade have strengthened governance and investment.

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The Indian stock market rebounded, but the short-term aftershocks have not subsided. Wind data shows that on Tuesday, India's main stock index, the Nifty index, and the Indian SENSEX index both plummeted by 8%, hitting a new low since January. By the close, the Indian Nifty index closed down 5.93%, at 21,884.50 points. The Indian SENSEX index closed down 5.74%, at 72,079.05 points, marking the largest drop since May 4, 2020, in four years. Small and medium-sized stocks fell by 8%, and most cyclical industries closed down 10%-15% on the day. Just one day before, the Indian SENSEX index had just set a historical high of 76,468.78 points.

However, after the sharp decline, the market began to stabilize and rebound, but institutions still held a wait-and-see attitude. "We believe that the market may fluctuate before the Prime Minister takes the oath of office, and some key issues still need to be clarified," an Indian local investment institution told reporters.

Barclays said that after the Bharatiya Janata Party (BJP) "surprisingly lost the majority of seats," all eyes turned to the members of the new government's cabinet. "Since the BJP still maintains the position of the largest party with a significant advantage, we believe it will be able to secure the four highest positions in the cabinet under the leadership of Prime Minister Modi - the Ministry of Home Affairs, the Ministry of Defense, the Ministry of Finance, and the Ministry of Foreign Affairs."

In view of the Indian election results being less than expected, Modi's Indian nationalist party BJP unexpectedly lost the majority of seats in the parliament enjoyed in the previous two terms. Modi sought to form a coalition government and is expected to take the oath of office on June 8, starting his third term.

Analysts believe that India has made great progress in achieving macroeconomic stability in recent years, by reducing the current account deficit, controlling inflation within the target range of the Reserve Bank of India (RBI), and consolidating the fiscal deficit. The reduction in the majority of seats once caused the market to worry about India's subsequent maintenance of macroeconomic stability, but most opinions still believe that the impact is limited.

Goldman Sachs mentioned in its research report that this is the first time in the past decade that the BJP has not obtained a majority of seats in the House of Commons alone. "Their main challenge will be to manage coalition partners, who may demand to nominate their members to serve as ministers in some key ministries. We believe that the weakening of political power will make it difficult to pass structural reforms, such as land reform to promote manufacturing growth, and agricultural sector reform to increase agricultural productivity growth."High Valuation Remains the Main Cause of Significant Declines

Despite this, the majority of investment institutions believe that high valuations are still the main reason for the short-term significant declines in the Indian stock market, but investors may still return after the correction.

JPMorgan's Chief Asia and China Equity Strategist, Liu Mingdi, previously stated to reporters that, generally speaking, when the price-to-earnings (P/E) ratio of Indian stocks falls to 17 or 18 times, investors tend to be interested. "Last February, we indeed had a positive attitude towards India because the market experienced a correction at that time. Currently, the P/E ratio of the Indian stock market is around 22 times (high), and our analysts believe that buying may return after the election, as the attractiveness of medium-term structural growth is still relatively high. In some Asian markets, corporate management prefers growth over profits, and Indian companies may strike a better balance between growth and profits."

Goldman Sachs mentioned that although a P/E ratio of 22 times is not cheap, India continues to provide strong earnings. Earnings grew by 20% last year, and first-quarter profits increased by 16% year-on-year, exceeding expectations. "We expect an average annual earnings growth rate of 15% for 2024 and 2025, which will drive market returns. Given the weak capital inflows so far this year and the low position of foreign holdings, we expect foreign capital to return."

In fact, the Indian stock market has been one of the best-performing markets globally in recent years, and many fund managers from international asset management institutions have told reporters that the Indian stock market has been relatively expensive. Franklin Templeton mentioned that over the past three years (up to the end of April this year), the MSCI India Index has risen by about 12.5% per year (in US dollars). In comparison, the MSCI Emerging Markets Index has decreased by 8%, while the MSCI Global Index has risen by 2%.

"This outstanding performance is not just a recent flash in the pan, but a continuation of the trend over the past 10 years, and even the past 30 years. If we go back to May 31, 1994, the return on the MSCI India Index is 66.6%, while the MSCI Global Index is 5.4%, and the MSCI Emerging Markets Index is 2.5%. The long-term outstanding performance of the Indian stock market is a reflection of India's GDP growth," Sharma told reporters.

India's share of global GDP has increased from 1.1% in 1993 to about 3.5%. It is clear that India's rise is not a short-term phenomenon but the result of long-term accumulation. Some opinions suggest that India may surpass Germany and Japan in the future to become the world's third-largest economy, and the performance of the Indian stock market is strongly correlated with economic growth.

Sharma said that several factors have driven international investors to increase their holdings in the Indian stock market in recent years. Among them, the most critical factor is the increase in income. It is expected that by 2025, the average annual urban per capita income will reach $3,000, and consumption capacity will increase; structural reforms are also indispensable, with improved quality of government spending, increased government efficiency, and improved business environment; in addition, digital transformation has entered the takeoff stage, such as the digital public infrastructure "India Stack," which includes identity, payment, and data layers; the upgrade of the manufacturing industry has attracted global attention, mainly supported by the Production-Linked Incentive (PLI) scheme and also benefiting from the trend of global supply chain diversification.

He also mentioned that India's "consumption story" has attracted attention. "We expect India's affluent and middle class to expand to 400 million people. In particular, the number of India's affluent class will triple, marking the birth of a new consumption category, namely the high-end category, which is currently not common in India."

However, Sharma said that the contribution of India's manufacturing industry to GDP is only about 13%, compared to a ratio closer to 20% to 30% in markets such as China, Vietnam, and Bangladesh.Additionally, whether India can transform its vast population into a demographic dividend remains a matter of concern among various sectors. India's median age is only 28 years old, but the young population needs employment. Fullerton Investment has previously mentioned that before the concept of "population superpower" in India became popular, demographic structure has never been a necessary or sufficient condition for economic development. India has long been experiencing "low employment" growth. Entering the era of automation and artificial intelligence, creating job opportunities for the country's large and still growing population will be even more challenging.

Capital once flowed out of India and into Chinese stock markets.

It is worth mentioning that in the MSCI Emerging Markets Index, India, South Korea, A-shares, Hong Kong stocks, and Chinese concept stocks play a major role, and changes in each market can impact the index and capital flows.

According to information gathered by the reporter from several foreign investment banks and asset management institutions, in the past few months, some foreign institutional investors have shifted from the Indian stock market to China. The Indian stock market's price-to-earnings ratio previously exceeded 21 times, while the MSCI China Index had a price-to-earnings ratio of less than 8 times before rebounding, and now it is just over 10 times.

Since the end of May, the Chinese stock market has also fallen into a correction, and most overseas long-term capital has not yet followed quantitative and hedge funds into the Chinese market. Franklin Templeton mentioned to the reporter that China's recent stimulus measures aimed at stabilizing the real estate industry are the reasons for the recent market bottom and rebound. However, at the same time, economic recovery still requires time. "After the recent rise, I believe that the equity risk premium has returned to the mean to some extent. Therefore, the sustained stock performance from here on needs to be supported by earnings growth. In the recent earnings season, some companies' performance still faces certain pressures."

However, the institution also stated that from a bottom-up perspective, China is also a vast and deep market, just like India. "Therefore, we continue to focus on companies that benefit from economic growth, have strong competitive advantages, can generate substantial free cash flow, and are willing to reward shareholders."