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Bear Market for India ETFs Following Modi's Election?

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Indian equities skyrocketed for quite some time and finally gave in to the law of gravity. After returning more than 50% so far this year, India’s small cap market shed 10% last week while large cap stocks slid about 5% following a gain of over 20% in the year-to-date frame.

This surge in the markets was driven by the Narendra Modi led Bharatiya Janata Party (BJP)’s win in the general election held in mid May. Pro-reform Narendra Modi as India’s prime minister raised optimism about the nation and stocks surged (read: Indian Elections Led to a Surge in These 3 ETFs).

Foreign investors poured in about $3 billion into the Indian stock market on hopes of a stable government that will ensure better economic health. Not only the change in government, a new chief of India’s central bank also brought back much-needed strength in the Indian market which was hit hard last August by rupee depreciation.

Reserve Bank of India’s new governor Raghuram Rajan shored up the currency reserves by about 16% since last September to safeguard the domestic market from a potential cease in cheap dollar inflows in the wake of QE wrap-up and to prepare for the blow in case the Fed raises interest rates next year.

However, rise in wholesale inflation to a five-month high level, profit-booking activity from this bloated market, possibility of poor monsoon this year and militant attacks in Iraq all played their roles to drag down the towering stock market to ground reality (read: India ETFs: Can the Surge Continue after Elections?).

Downside in Detail

Per Bloomberg, monsoon – the prerequisite for India’s irrigation system, has so far been weak this year with 49% less rainfall from the 50-year average this June. If the situation persists, the nation is due for another round of food price inflation in the coming months. Notably, India has long been plagued with heightened consumer inflation, which is the fastest in Asia.

The second blow came in the form of militant attacks in Iraq that resulting in a surge in oil prices. As we know by now, the possibility of a civil war in this oil-rich OPEC nation pushed oil prices up to the highest level in nine months.

Notably, India imports more than 75% of its oil requirements, thus being highly susceptible to such geo-political shocks. Per the US Energy Information Administration, India is the fourth-biggest importer of oil across the globe.

Financial Times reveals that Barclays estimates a $10 per barrel rise in crude oil price would cost India a 0.5 percentage points in its growth rate. Thus, if crude prices continue to see an uptrend, India will probably have to shell out all its so-far-saved foreign exchanges to pay the higher import bills. In such a case, concerns over the falling rupee and widening current account deficit will be back on the table (read: Uprising in Iraq Puts These Oil ETFs in Focus).

The third and the most likely reason for the bear spell was the profit booking activity. With the Sensex trading at 15.5 times estimated 12-month profits (per Bloomberg), stocks are now trading at the highest level in more than three years. Needless to say, the Sensex topped all the emerging market equities. Who would not want to book profits out of this market?

ETF Impact

At the time of writing, all the India-related ETFs including WisdomTree India Earnings (EPI), India Small-Cap Index ETF (SCIF),  India Small Cap ETF (SCIN), PowerShares India Portfolio (PIN), iShares S&P India Nifty 50 Index Fund (INDY), iShares MSCI India ETF (INDA), India Consumer ETF (INCO) and iShares MSCI India Small-Cap ETF (SMIN) retreated 5.52%, 10.09%, 9.35%, 4.31%, 3.91%, 3.12%, 4.15% and 6.47%, respectively, over the last five days (as of June 16, 2014) (read: India Election Results: Can Indian ETFs Roar Higher?).  

Is This the Start of a Bear Run?

Probably not. Many analysts still seem bullish on this market. According to Bloomberg, despite a phenomenal rally this year, it is still 26 percentage points below the average Indian bull market over the last 30 years.

Moreover, the Sensex’s valuation is still way behind (around 28%) its all-time high in 2007. With the earnings picture brightening for this year, this pent-up potential in the stock market will likely show more magic in the coming days.

Not only foreign buyers, local investors are also active. In fact, local mutual funds accounted for $416 million of inflows in May – the highest in five years.

Other Factors

Meanwhile, investors saw some more plans from the government, a factor which could help equities. President Pranab Mukherjee summarized the new government’s ventures on June 9.

These include launches of high speed trains; construction of 100 new cities with top-notch amenities, investing in agri-infrastructure, simplifying tax structure, containing most-worrying food inflation and more. If these plans receive proper execution, the Indian equity market will see further rallies. 

Still, we caution investors to be hawk-eyed while investing in this market. Though the Sensex is yet to reach its historic-high valuation, it is trading at over 40% premium to the MSCI Emerging Markets Index.  This sort of valuation always bears risk. Even if the internal fundamental remains steady, any sort of global shock might pull the stock down from its heights.
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