We'll know the results of India's election on Thursday. Investors best position themselves today.
Exit polls indicate a strong win for the incumbent Prime Minister Narendra Modi, and his Bharatiya Janata Party, or BJP. If the polls are right -- and they've often been wrong, sometimes "Dewey Defeats Truman" wrong -- the BJP's coalition, the National Democratic Alliance, should win in a landslide.
If the BJP performs particularly well, it may not even need any coalition partners to form a government. It may cross the majority 272-seat mark all on its own.
This is very good news for the markets. Modi has been championing economic and corporate reform in perhaps the most-bureaucratic nation on earth. The world's largest democracy does not always function smoothly, but Modi is doing his level best to improve its efficiency.
But a Modi victory also comes with a number of caveats. The prime minister, who has drawn on the power of his personality to win reelection, is a fiery nationalist who doesn't mind stoking patriotic and ethnic tensions if he has to. In that respect, it's a positive if the BJP does win an outright majority by itself -- their primary coalition partner in the National Democratic Alliance is in the Shiv Sena party of fervent Hindus.
The BJP will come with less religious baggage if it comes on its own. It recorded a surprisingly large victory in 2014, then sidelined Shiv Sena. Expect more politicking even once the results come out.
That's the fine print on a business-friendly victory. Indian equities are, however, near an all-time high. Do they have further to go?
The answer is likely a "Yes." Overseas investors have been climbing into Indian stocks this year, pumping $9 billion into the market. But they've taken a breather as the election took place over the last five weeks. It has taken seven rounds of voting to get the 900 million eligible voters to a polling station, and there was a blackout on polling while the voting took place.
Domestic investors have been waiting until the results are confirmed. They have accounted for only $500 million out of the US$4 billion that flowed into Indian mutual funds in the first four months of the year.
With the elections out of the way, the focus will return to earnings, while both public and private capex should pick up. Domestic investors may be more enthused.
Investors would do well to focus on domestic cyclicals where momentum is improving, according to the SG team. They also highlight capex-intensive sectors such as industrials and building materials.
There's been lackluster growth in the consumer sector lately, particularly automobiles. But SG believes that is a cyclical slowdown and linked to tightening in shadow banking, which has constrained liquidity.
"We think the structural drivers of the India consumer story are still intact, and find the consumer-discretionary sector attractive after a strong underperformance over the past six months," SG's Asian equity-strategy team, led by Frank Benzimra, note.
Indian domestic growth certainly looks a safer bet than the rest of Asia during this time of heightened trade tensions. I expect that the renewed hostilities between the United States and China will soon dent consumer and business confidence inside China, resulting in reduced consumer spending and capex in China.
Indian equities had their strongest one-day rally in three years on Monday, rising 2.0% by the Tuesday open. But their year-to-date performance, with the Sensex index up 8.4%, is hardly outrageous.
Overseas investors should definitely restrict themselves to big-cap Indian stocks, which are what you'll find in the Sensex, as it tracks 30 of the biggest names. Likewise, the "Nifty 50" index tracks the largest, most-dynamic Indian companies.
The iShares India 50 ETF (INDY) is the ETF to favor for Nifty 50 exposure. It is up 8.2% year to date. There's more mid-cap inclusion in some other indexes, such as the MSCI India Index, which mirrors the performance of 80 constituents that make up 85% of the market. As a result, the iShares MSCI India ETF (INDA) has advanced less than the Nifty 50 product, up 5.4% this year.
The iShares MSCI India Small-Cap ETF (SMIN) is up only 0.4% in 2019, while the VanEck Vectors India Small-Cap Index ETF (SCIF) is down 4.0% this year. Indian small-caps will likely rally when a risk-on attitude returns, and global investors favor emerging market stocks globally.
There's even a Direxion Daily India Bull 3x Shares ETF (INDL) , which magnifies long exposure to Indian equities. But investors are not really rewarded for that extra risk. It is up 10.0% so far in 2019, which is the best performance among all India ETFs. But the ETF will go rapidly into reverse if performance isn't as expected, and its gains are not that far ahead of the Nifty 50 fund.
Enhanced-exposure funds, whether bull or bear, also show a greater propensity to veer away from the performance of the underlying index they follow, due to the derivatives cost necessary to generate them. They're best used only by day traders or short-term hedging.