India ETFs May Triple In 5 Years

Analyst covering Indian equities says earnings growth will propel the market much higher from here. 

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Senior ETF Analyst
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Reviewed by: Sumit Roy
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Edited by: Sumit Roy

It's been a fantastic year for Indian equities. So far in 2017, the largest ETF targeting the country, the $5.2 billion iShares MSCI India ETF (INDA) is up 26.2%, besting the returns for broader emerging market funds such as the Vanguard FTSE Emerging Market ETF (VWO), up 18.6%, and the iShares Core MSCI Emerging Markets ETF (IEMG), up 22.6%.

But as good as those gains in India ETFs have been, they're about to get even better in the coming years. That's according to Ridham Desai, Morgan Stanley's head of research for Indian equities. Desai spoke on a recent podcast hosted by WisdomTree, the issuer of the No. 2 India ETF by assets, the $1.7 billion WisdomTree India Earnings Fund (EPI), and he had plenty of bullish things to say about the Indian market and economy.

 

YTD Returns

 

His most striking claim was that he expects the Indian stock market to triple over the next five years. The catalyst? An acceleration in corporate earnings from what he sees as rock-bottom levels.

Strong Profits, Reasonable Valuations

"The growth cycle is turning," said Desai. "This new growth cycle may cause earnings for the market to compound at around 20%."

That may seem like a lot, but in the previous cycle between 2003 and 2008, corporate earnings compounded at 39%, according to Desai. He doesn't expect growth to be as heady this time around because the global economy is unlikely to be as supportive, but 20% "is still a good number," he pointed out, adding that the ratio of profits to GDP is currently at a very low base.

Meanwhile, valuations for Indian equities are reasonable, in his view. "I tend to look at price-to-book rather than price-to-earnings (P/E), because earnings are depressed, so P/E's are distorted," remarked Desai. "India is trading at 3.2x book, which is bang in line with history, so there's nothing in the valuations to get worried about."

Combine robust profit growth with fair valuations, and you have a recipe for a stock market surge.

"If I'm right about the earnings call, then the stock market can compound at faster than 20%, because the nature of markets is to get optimistic as you get more growth, so multiples go up," argued Desai. If share prices increase at a compounded 24%―just a little faster than his expectation for earnings growth―then the Indian market can triple in the next five years.

 

Huge Domestic Inflows Into Equities

Aside from earnings growth, Desai rattled off many other bullish factors that will support the Indian economy—and by extension, Indian stocks—in the coming years.

Notably, he expects Prime Minister Modi to come back for another term in 2019. He also anticipates there to be a structural shift in Indian households' investment portfolios, where they begin buying more equities than they have in the past.

One of the reasons for this structural shift is because the Indian central bank has changed its stance, and now has an explicit policy of keeping real rates positive, which is dampening demand for physical assets―most notably gold―and bolstering demand for equities.

Desai forecasts Indian households can invest $400 billion to $500 billion into Indian equities over the next 10 years. Unless that's matched by a huge increase in supply, "there's going to be excess demand for Indian equities" for years to come, he said. "It's like the 401(k) moment in the U.S. back in the ’80s."

A More Measured View

Preceding Desai on the webcast was Viral Acharya, the deputy governor of the Reserve Bank of India, who also had an optimistic, but more measured, forecast for the Indian economy.

Acharya believes the structural reforms taking place within India may lead to slower growth in the short term and faster growth long term.

Those reforms include the goods and services tax that went into effect just this week and the new law on insolvency and bankruptcy that's been in place since December, the latter of which "is going to be a big step forward" for the corporate bond markets, according to Acharya.

At the same time, "addressing nonperforming assets or stressed assets on the balance sheet of banks," is a key issue for the economy, said Acharya. "If resolved right, it would reduce the excess capacity and indebtedness of [certain] sectors" and "unlock the growth potential of the economy."

"My opinion is that it's better to accept slower growth for a short period as long as you’re doing the right structural reforms to resurrect that growth to a higher level," the deputy governor said. "What doesn't work well is when you just do temporary fixes and you just put a band-aid on what needs a deeper reform."

Contact Sumit Roy at [email protected]

 

Sumit Roy is the senior ETF analyst for etf.com, where he has worked for 13 years. He creates a variety of content for the platform, including news articles, analysis pieces, videos and podcasts.

Before joining etf.com, Sumit was the managing editor and commodities analyst for Hard Assets Investor. In those roles, he was responsible for most of the operations of HAI, a website dedicated to education about commodities investing.

Though he still closely follows the commodities beat, Sumit covers a much broader assortment of topics for etf.com, with a particular focus on stock and bond exchange-traded funds.

He is the host of etf.com’s Talk ETFs, a popular video series that features weekly interviews with thought leaders in the ETF industry. Sumit is also co-host of Exchange Traded Fridays, etf.com’s weekly podcast series.

He lives in the San Francisco Bay Area, where he enjoys climbing the city’s steep hills, playing chess and snowboarding in Lake Tahoe.