SINGAPORE (Aug 27): The Tantallon India Fund closed 1.29% higher in July, after expenses. The broad market recovery and the rotation into large-cap stocks mask the continued risk-off in the smaller and medium-sized companies. However, the nascent earnings season affirms that the recovery in the real economy is underway, and as operating leverage kicks in, revenue growth and margin uplift would appear set to surprise positively on the upside.

The pros and cons:

  • Largely insulated from the risk of damaging trade restrictions and punitive retaliatory tariffs, India’s domestic economy is structurally accelerating relative to the rest of the world. Having just returned from three weeks of company visits, it is clear that corporate confidence is at a multi-year high as real GDP growth sustains at a 7%+ run-rate, as policymaking is geared to incentivise the deployment of risk capital, as industry utilisation rates improve off decade lows, and as top- and bottom-line growth inflects to the upside;
  • Having front-loaded two rounds of rate hikes in June and August, the Reserve Bank of India is committed to maintaining its hard-won inflation-targeting credentials. We would specifically point to the recent steepening of the yield curve (which is currently at post-2010 highs), and its historical correlation with positive equity returns;
  • Domestic retail flows into equities have been sustained around US$2.5 billion ($3.4 billion) a month, creating a good base for the market/valuations — despite sustained foreign institutional selling in the first half of the year (foreign institutional ownership in the market is back to 2011 levels);
  • The risk of higher energy prices and the stress it potentially implies for the current account/fiscal deficit, inflationary expectations/monetary policy and the currency. Yes, higher energy prices are inherently inflationary, and a potential drag for the rupee (currently trading 7% lower on the year, close to its all-time low), and for Indian equities. That said, Prime Minister Narendra Modi’s deliberate efforts to cut back energy subsidies, and a stable current/fiscal account, would suggest that we are well positioned to avoid the damaging boom/bust cycles of the past.
  • The attendant uncertainties of the upcoming general election (which needs to be held by May 2019), both in terms of potentially populist policy actions in the near term, as well as whether Modi will retain a parliamentary majority to sustain his reformist agenda;
  • We are more sanguine than the market pundits on both Modi’s commitment to fiscal discipline and ongoing reforms, and his retaining a parliamentary majority. We would reiterate that we are substantially more constructive than consensus on sustained topline growth, margin uplift and very strong earnings/cash flow growth; and
  • Domestic equity valuations (on consensus estimates) would seem to be at the top of their historical trading range relative to bonds, suggesting that the market is starting to price in some of the reset in earnings expectations.

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