Indian stocks have been on a tear this year amid optimism about the country’s new government, but political uncertainty and rich valuations should give investors pause.
In the first eight months this year, India equity funds led all Morningstar categories with a return of nearly 30%. For the trailing 12 months, those funds were up by almost 60%.
“This year’s election, in which Narendra Modi became the nation’s prime minister, has been the main reason for those returns,” says Mark Luschini, chief investment strategist at Philadelphia-based Janney Montgomery Scott. “There was enormous investor enthusiasm during the election campaign, as the polls started to show a Modi victory, and the optimism has continued.”
India has appealing long-term potential, Luschini says.
“It’s a populous nation, with a young population. However, India is fragmented,” Luschini says. “With one party in control for most of the past 60 years, there is a huge amount of inertia to overcome in order to increase economic growth,” he says. “With a new prime minister from a different party, there probably will be structural reforms to bring more people into the middle class, but it will take time for change to come.”
Although Luschini doesn’t think that Indian stocks are overvalued, he calls them “richly valued,” and he isn’t buying now.
If there is a correction, either because of a global equity slide or local disenchantment with the pace of change in India, he says he might recommend buying.
In addition, advisors who prefer to use individual stocks will find that foreign investors face stringent regulations and high costs in India, says Jun Zhu, a senior analyst with the Leuthold Group, an institutional research firm in Minneapolis.
“We have found the best way to get exposure to individual Indian stocks is through American depository receipts and global depository receipts,” she says.
“They are available for many large-cap companies, in enough industry sectors to put together a diversified portfolio,” Zhu says. “For small- and mid-cap Indian stocks, investors probably will have to use funds.”
ECHO IN BRAZIL
Luschini likens India’s situation to the environment in Brazil, where stocks are up about 15% this year, reaching a 19-month high this month.
A campaign for an election next month is under way in Brazil, with Marina Silva challenging President Dilma Rousseff.
“Brazil’s economy is in a recession, yet Brazilian equities are performing well,” Luschini says. “Silva has been gaining in the polls, and those gains are encouraging investors who are hoping for change.”
Again, Luschini finds Brazilian equities “fully valued,” so he is waiting to buy after a possible correction.
In case of a market pullback, local or global, Luschini says that his firm is likely to take positions in individual stocks from India or Brazil or invest through single-country funds.
A single-country fund could be a Brazilian or an Indian [exchange-traded fund], for broad exposure to the selected market, or an actively managed entry with an attractive record.
Donald Jay Korn is a Financial Planning contributing writer in New York. He also writes regularly for On Wall Street.