The world’s fifth largest market

The Indian stock market has long operated in the shadows of its Chinese counterpart, but with a market capitalisation that has just crossed the US$4 trillion mark, global investors are suddenly sitting up and paying attention.

India’s market cap has grown by 60 percent over the past three years, and is now larger than every European stock market. Its size is currently only surpassed by the US, China, Japan and Hong Kong.

When adjusted for free floats and excluding small caps, as in the case of the MSCI AC Asia ex Japan index, India becomes even more important. It now occupies 20 percent of the index compared to 12 percent in Jan 2021, making it the second-largest component. Over the same time frame, China’s share of the index has fallen to 30 percent from 48 percent previously.

India up, China down

This market cap growth has been made possible by India’s consistently strong stock market performance over the past three years. As a result, India’s 2020 to 2023 performance is outstanding, beating the second-best performer, Taiwan, by more than double. China on the other hand was the region’s biggest underperformer.

Fig 1: Select Asian stock market performance over 1 and 3 years (%)

Source: Bloomberg/ UOBAM, Dec 2023

India’s stock performance is powered by good corporate profitability. Corporate profits as a share of GDP is now close to 5 percent, bolstered by strong earnings growth. According to Morgan Stanley analysts¹, Indian corporates are experiencing a profit upcycle that could bring this share to 8 percent in the next three to four years.

Growing by leaps and bounds

India is today the world’s fifth largest economy and this year, is also expected to be one of the fastest-growing. The Asian Development Bank’s (ADB) latest forecast for 2024 puts India’s growth at 6.7 percent, a good distance ahead of all other Asian markets.

Asia’s largest economy, China, announced last week that its GDP grew by 5.2 percent in 2023, but the ADB expects this to fall to 4.5 percent in 2024, amid a number of growth challenges, including falling exports.

On the other hand, India’s GDP is expected to stay above 6.0 percent over the next few years, driven primarily by strong private consumption. Unlike in China where the savings rate is still high, positive sentiment in India is encouraging credit-fueled spending, with household debt now at a 15-year high.

India is also enjoying robust industrial and services activity, and the latest leading indicators are very encouraging. Both the Manufacturing PMI (Purchasing Managers Index), currently at 54.9 and the Services PMI at 59.0 are well above the 50 threshold.

Several risks ahead

Despite this rosy picture, we would sound a note of caution. While we continue to benefit from our India holdings, we believe that the market’s overall PER (price earnings ratio) at around 20 times, is over-extended relative to historical levels.

Also, we think the India market’s EPS (earnings per share) growth projections do not justify such high prices, especially when compared to other markets in Asia. China and Taiwan’s 2025 EPS growth is forecast to be similar to, or higher than, India’s, yet their PERs are far lower.

Figure 2: Valuation forecasts by market, 2024 – 2025

Source: UOBAM/ FACTSET/ FACTSET MKT AGGREGATES, 9 Jan 2024

Market valuations aside, any risks to India’s consumption demand could cause its strong growth to falter. Of immediate concern is inflation, and in particular food inflation. In December 2023, food prices increased by 9.5 percent year-over-year and the situation could worsen if poor weather conditions continue to affect grain production. High food prices would steer demand away from other sectors.

Similarly, Indian officials are worried that an escalation of hostilities in the Middle East could cause a spike in oil prices. As an oil-importer, India is vulnerable to oil price rises, and experts say an increase of US$10 to US$20 could start to negatively impact India’s economy and add to inflationary pressures.

Over the longer term, it is worth noting that the average per capita income is currently just US$2,500 per annum, less than a quarter of China’s. Failure to address current poverty levels and wealth disparities could end up limiting the country’s consumption growth trajectory. On the other hand, such low levels suggest plenty of room for improvement.

Be selective

UOBAM is optimistic about India’s economic momentum. The country’s financial markets are also set to see significant fund flows as investors continue to shun China equities.

However, we remain on the lookout for positive earnings revisions. In the absence of such revisions, we would consider the market to be extremely rich and would not be surprised by some market correction in the next few quarters.

We would therefore recommend a selective approach to Indian equities, with a focus on stocks that have a high potential for their valuations to be re-rated positively.