CNBC's Inside India newsletter: Discovering a stock market substitute

This report is from the CNBC "Inside India" newsletter, which provides timely and insightful news and market commentary on the emerging powerhouse and the big businesses driving its rapid growth. If you find it interesting, you can subscribe here.

The big story

Recently, India's stock index was outperforming the global index this year.

The Indian benchmark has lagged behind the 8% rally in U.S. stocks since the Aug. 5 sell-off.

The strong U.S. economy has contributed to much of the American outperformance, while the Indian equity market's lackluster performance can be attributed to its inability to meet investor expectations.

In the first quarter of the past year, earnings for Nifty 50 companies increased by 3%. However, when banks and energy firms are excluded, the remaining companies only managed to achieve earnings-per-share growth of 19% in the most recent quarter, compared to the same period last year.

The stock market is a forward-looking beast, and the above was expected. In fact, only 21 out of the 50 companies that make up the index surprised investors. The rest simply couldn't keep up.

Even if a few companies outperform expectations, it won't significantly impact investors' overall returns, as many analysts fear the market will soon fail to meet expectations.

"According to Amish Shah, equity strategist at Bank of America, while potential beats in Autos, Industrials, Healthcare, and IT may not be enough to offset the misses in Financials, Metals, and Energy, there is also the risk of slowing global growth."

A potential slowdown in global economic growth may negatively impact commodity prices, but it is unlikely to significantly affect India's growth trajectory.

Although the South Asian nation has a consumer-led economy with exports not being a dominant feature, a decline in oil prices due to a global slowdown could benefit the country as lower fuel costs increase citizens' discretionary spending.

The Nifty 50's energy sector, which accounts for a significant portion of the index, has a relatively small impact on the Indian economy's GDP growth. Any decline in oil and gas firms' earnings could lead to unstable returns for investors.

Citi has projected that Nifty 50 companies' earnings per share must increase by 13% annually for three years to meet investor expectations. However, this is a challenging task, as it falls short of even more optimistic projections from earlier.

"Surendra Goyal, head of India research at Citi, stated that earnings revision have become flattish since July, despite still being better than long-term trends. He added that there are limited upsides at current levels and he would be a buyer on any dips."

Should investors sell out? Is it worth risking future potential profits?

A group of investors believe they have found a solution to the problem by investing in bonds.

"Maximilian Macmillan, a senior investment director at U.K. asset manager Abrdn, stated that Indian equities are experiencing strong price momentum and earnings growth, but are highly correlated to and dependent on the continued performance of US equities in a late cycle environment. He advised that bonds offer diversification from this dominant and singular source of performance, though they are not risk immune."

Since early 2023, bond funds have had net inflows continuously, while foreign fund flows into Indian bonds have surpassed those into equities so far in 2024.

In the past two years, foreign investors have been pulling money out of equities one out of every four months.

Despite fluctuations in foreign investments in equities, India is experiencing increased foreign debt inflows due to its sovereign bonds being listed on global bond indexes, according to Shumita Deveshwar, chief India economist at TS Lombard.

India-specific bond funds have also contributed significantly to the influx of funds into the country's bond market.

Indian government debt can be met through actively managed funds such as Abrdn's and Invesco's India bond funds, which offer yields over 7%. Additionally, ETFs from iShares, L&G, and Xtrackers have also made it possible to meet the increased demand for Indian government debt.

According to Kenneth Akintewe, head of Asian debt at Abrdn, they are one of the few investment grade asset classes offering yields of around 7%, making it an excellent entry point for investors, especially since yields are higher than the Indian policy rate of 6.5% and the latest inflation print of 5.1%.

Need to know

The Disney-Reliance merger, which aims to create India's biggest entertainment player, has raised concerns over competition due to their power over cricket broadcast rights. The merger will compete with Sony, Zee Entertainment, Netflix, and Amazon with a combined 120 TV channels and two streaming services.

Asian countries are closely monitoring Mpox, formerly known as monkeypox, after the World Health Organization declared an escalating outbreak in Africa as a global public health emergency. China's custom authorities said they will strengthen surveillance at ports of entry, while India said Prime Minister Narendra Modi has been continuously monitoring cases in the country.

Doctors in India are protesting against violence by turning away patients except for emergency cases. More than one million doctors are expected to join the strike, which will paralyze medical services in the world's most populous nation. The strike was triggered by the brutal rape and murder of a 31-year old trainee doctor in Kolkata last week.

What happened in the markets?

Indian stocks have increased in tandem with their global counterparts. The index has gained approximately 1% this week, and it has risen 14% in the year.

The benchmark 10-year Indian government bond yield has crept lower to 6.85%.

According to Praveen Jagwani, CEO of UTI International, a favorable monsoon season will positively impact the Indian stock market. He stated, "The Indian market is cyclically synchronized with the monsoon season."

Mark Mobius, a seasoned investor in emerging markets, predicts that there will be a correction in the Indian stock market due to the unraveling of the Yen carry trade. However, he anticipates that the bull market will return shortly after.

What's happening next week?

Next week, both Interarch Building Products and Orient Technologies will make their debut on the stock market as prefabricated building supplier and cloud services provider, respectively.

August 23: Japan inflation

August 28: Russia industrial output and unemployment rate

August 30: U.S. core inflation