The Elephant and the Bull Market

The Elephant and the Bull Market
India's stock markets have had a wild ride this year, as foreign investors have piled in. But can the good times last?
By John Elliot, Fortune


(Fortune Magazine) -- At the epicenter of India's booming stock market, on Mumbai's Dalal Street, there's hardly any sign of frenzy. A few dozen people stand outside, laconically watching the electronic ticker. Several murmur into phones behind cupped hands, as vegetarian-snack vendors sell samosas and sub-brokers hand out company prospectuses.

Inside, the Bombay Stock Exchange's once-rambunctious trading floor has long since closed. Now brokers place orders quietly and electronically from elsewhere.

But the calm belies what's really going on - an unprecedented run-up in stock prices fed by foreign-investor enthusiasm about India's economic growth, averaging 9% over the past three years. In the past three months more than $7.9 billion in foreign equity capital has flooded in, pushing the market up such a steep curve that the key Sensex index gained some 3,000 points, or 17.5%, in just 33 days this fall.

The market, which has slipped a bit from its Oct. 29 peak of 20,000, is not for small retail investors, who account for no more than 7% of the $1.3 trillion capitalization of the Bombay and National stock exchanges.

"There's no euphoria on the streets, because ordinary local investors feel left out," says Manish Chokhani, a director of Enam Securities, a leading local brokerage. "It's too late for them to come in now."

Instead, foreign institutional investors have stepped in, doubling their stake to an estimated 25% of the Indian market. "Since earnings and economic growth became scarce worldwide," says Jyoti Jaipuria, head of research at DSP Merrill Lynch, an Indian joint venture with the U.S. brokerage, "people have been prepared to pay in a place like India, which still stands out with growth potential."

A good India story

But will the bull market last? The question for investors now is whether India can remain an attractive safe haven or whether the trend will reverse, either because of domestic or international setbacks or because corporate earnings don't match expectations.

Certainly there are reasons for concern. Price/earnings ratios remain high (the average multiple for the 30 companies that make up the Sensex index is 27).

About $1 billion in foreign-equity investment left the country in November, as investors took profits and the Sensex fell to around 19,000. Indian regulators, worried about the impact of hot money, restricted the inflow from unregistered sources such as hedge funds.

Some economic indicators were also pointing in the wrong direction. Industrial growth fell in September to 6.4%, an 11-month low, from a high of about 11%, mainly because increased interest rates reduced demand. But the declining value of the dollar, which has dropped by more than 11% against the rupee this year, has also had an impact on exports.

Still, India's economic prospects remain strong, with overall economic growth forecast at about 8% next year, a youthful population, and rising consumer demand.

Rakesh Jhunjhunwala, Mumbai's highest-profile private investor, reflects a majority view of short-term caution and longer-term confidence. "I don't think it's a bubble," he says. "But it's time to consolidate holdings: Don't buy - and hold on to what you have." Deepak Parekh, chairman of HDFC, India's leading housing bank, agrees: "I'm not a big bull, but we are looking at 8% to 9% GDP growth, and that is a good India story."

Sensex winners and losers

Foreign investors focus heavily on the 30 stocks in the Sensex. That is a tiny faction of India's more than 7,000 listed companies, but fewer than half of those are actively traded, and most fund managers stick to the indexed large-company stocks for fear of underperforming the Sensex.

Top among them is Reliance Industries, run by Mukesh Ambani, one of the world's richest men. This oil-to-retail conglomerate, which accounted for about 16% of the index's market cap at the end of November, has seen its stock soar some 125% this year.

Even more extraordinary is the performance of Reliance Petroleum, also controlled by Ambani, which is building India's largest refinery. The refinery isn't scheduled to be completed until late next year, and the company has no current income, but that didn't stop the share price from rising 70% in October. (It fell in November but still ended the month 30% above its Oct. 1 price.)

The second-largest company on the Sensex, by market cap, is ICICI Bank, India's leading private-sector bank. Other favorites include Bharti AirTel, the country's largest mobile-phone operator, and Larsen & Toubro, a leading engineering and construction group.

Analysts see all those companies as sound long-term investments, even though many say they wouldn't buy shares at current levels.

India's demand for infrastructure development - everything from roads to airports to hospitals- has made that sector a favorite of analysts. Companies like Larsen & Toubro in construction and Bharti AirTel in telecom, both leaders in their industries, are particularly well regarded.

Steel and cement companies, which feed into infrastructure projects, are also touted, along with health-care and pharmaceutical companies such as Ranbaxy and Dr. Reddy's.

Once-favored software stocks, such as Infosys Technologies, Wipro, and Tata Consultancy Services, have few takers. Over the past year Infosys's stock price has fallen by about 30%, despite the Mumbai bull run, partly because 98% of its revenue is based on exports, mostly to the United States.

But V. Balakrishnan, the company's CFO, says, "Interactions with customers do not indicate any slowdown in IT spending or any pullback on projects." Software company stocks have also declined, says Sachidanand Shukla, Enam's chief economist, because capital goods and other engineering stocks are producing better growth figures.

So steer away from software and go for stocks that will benefit most from domestic demand and India's need for better infrastructure. But be wary of the current prices of top Sensex stocks. Some analysts say it may be wiser to wait and see where the U.S. economy is heading and if India's poor industrial growth figures in September were just a blip.

In any event, the consensus is clear: Don't let short-term worries blind you to India's long-term growth prospects.