Neither oil, nor elections, the US Fed holds most sway over India's stocks

For all the domestic drivers of India’s stocks -- from oil to elections to shadow banking shakeouts -- the U.S. Federal Reserve holds the most sway, according to the nation’s biggest money manager.

Sankaran Naren, who helps manage 3.1 trillion rupees ($44 billion) as chief investment officer at ICICI Prudential Asset Management Co., says investors need to brace for a run of constrained returns that will last until the Fed’s Jerome Powell makes a policy U-turn. Key Indian equity indexes are up less than 10 per cent this year, and gauges of mid- and small-sized companies are poised for their first yearly decline since 2013.

“Once the U.S. interest-rate cycle changes and one moves to a situation where they say we are done with the quantitative tightening, then one may have a much more secular bull market in emerging markets and India,” Naren said in an interview in Mumbai last week. “We are in an accumulation phase of investing, where the near-term returns aren’t likely to be very high."

While the U.S. central bank’s influence on emerging assets is hardly an unknown phenomenon, India’s $2 trillion stock market has also been whipsawed in recent months by homegrown narratives. For Naren, those issues - including speculation on Prime Minister Narendra Modi’s election prospects in 2019, and a cash crunch in the non-bank financing sector - will mostly be resolved in the next year, leaving the Fed as the biggest factor.

Investors around the world will find out later on Wednesday whether Fed officials will reduce their "dot plot" trajectory for 2019, which currently implies three interest-rate hikes. Economists surveyed by Bloomberg have dialed back their expectations to two.

For the next year at least, Naren doesn’t see investments in Indian equities fetching more than “mid-teen” percentage in gains. “We shouldn’t talk of multi-baggers now, we can’t expect stocks doubling and one has to invest with expectations of lower returns than that,” he said. The $4.1 billion ICICI Prudential Balanced Advantage Fund -- the biggest that Naren manages -- has returned 12.85 per cent annually in the past five years, the best among its peers for that period, according to Value Research Ltd.

A more dovish Fed could help bring foreign investors back to India: they’ve sold more than $4 billion of the nation’s shares so far in 2018, the first year of outflows since 2011. The Dow Jones Industrial Average has outperformed the MSCI India and the MSCI Emerging Markets indexes in the past three years.

Still, local flows into equity funds have helped cushion markets. Investors have poured 1.2 trillion rupees into stock mutual funds this year, according to the Association of Mutual Funds in India. Naren likes small- and mid-caps, infrastructure stocks, banks and consumption-linked shares, he said. Non-bank lenders still aren’t cheap enough, he added.

Naren also said:

“We are currently placed in the middle of greed and fear. We are telling people that one shouldn’t be too bearish or too bullish.”

“The last accumulation phase in Indian markets was between 2010 and 2013, where people who invested got returns in the later years.”

“Flows in fixed income from retail investors are much lower than what I would like to see. I would like to see more flows in moderate-duration corporate debt funds as they give good returns.”

“Too much political uncertainty isn’t good for markets, it doesn’t help decision making for companies.”