Look before leaping into the world’s hottest stock market
Summary
Indian stocks are on fire. Investors who want to partake will need to keep a cool head as a trading frenzy and rising valuations have the potential to spoil the party.
Indian stocks are on fire. Investors who want to partake will need to keep a cool head as a trading frenzy and rising valuations have the potential to spoil the party.
MSCI India has surged 21% this year, beating most major markets—even the S&P 500, which is up 13%. In total, the Indian benchmark has more than doubled since the end of 2019.
There are fundamental reasons for investors to be bullish on the country. India’s economy is strong despite a recent slowdown, with gross domestic product in the second quarter up 6.7% year on year. That has helped drive earnings growth: Net income for the companies in the Sensex index rose 9% year on year in the second quarter, according to Morgan Stanley.
India has also benefited from geopolitical tensions between China and the West. As Western companies look to diversify their supply chains in the so-called China Plus One strategy, India has received billions of investments from companies such as Apple.
Foreign investors have streamed into the Indian market. Following outflows in the first half of this year, they have returned after Prime Minister Narendra Modi secured his third term in this year’s elections. Net inflows from foreign institutional investors into Indian stocks have been around $26 billion since the beginning of 2023.
Even so, much of India’s stock rally has been driven by domestic investors, especially from individual investors. Net inflows into equity mutual funds in India amounted to 3.6 trillion rupees, equivalent to $43 billion, since the beginning of last year until July of this year, according to the Association of Mutual Funds in India.
Increasing numbers of young Indian investors see the stock market as the quick way to riches. And many of them have been quite aggressive, flocking to derivatives offering leveraged bets with lottery-ticket-like payoffs. Relative to the market’s size, the boom exceeds the zero-days-to-expiration, or 0DTE, options frenzy in the U.S. market.
The total notional value of equity derivatives traded on the National Stock Exchange of India in the first eight months this year reached 63 quadrillion rupees, a 52% rise from the same period last year. Around $5 trillion notional value of derivatives are traded daily in September. A vast majority of them are very short-dated options, approximately a week, meaning that cash outlays often amount to less than 1% of the notional value. That is still a sizable sum, though—especially considering most lose money or expire worthless.
There has also been a boom in initial public offerings. IPOs in India totaled nearly $8 billion so far this year, already exceeding the total amount for all of 2023, according to Dealogic. That makes it the world’s second-largest IPO venue after the U.S. And investors are rushing into them, with many being more than 100 times oversubscribed, sending them surging in dot-com style on their first days of trading. Shares of solar-cell maker Premier Energies, for example, have already more than doubled after their first week of trading this month.
Mass frenzies are vulnerable to sudden shifts in sentiment, likely driven by a slowdown in the economy or earnings growth or external shocks. And Indian stocks are already at quite expensive valuations. MSCI India had a forward price/earnings ratio above 24 times at the end of August, compared with around 21 times for the S&P 500. And, unlike the U.S., smaller stocks are even more expensive: The Nifty Microcap index has surged 34% this year, outperforming the bigger companies. Small-caps on the Bombay Stock Exchange trade at 36 times trailing earnings, according to CEIC.
India is a promising long-term bet, but popular sentiment is impossible to predict and could spark a painful reversal.
Write to Jacky Wong at jacky.wong@wsj.com
