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India: Capture Regional Growth Via Ex-State-Owned Companies

Date: Thursday, April 4, 2019 7:54 PM EDT

Look at the irony of the emerging market (EM) equities.

When the American economy stalls, they tend to take the heat since America is the largest market for EM products.But when the American economy booms, EM equities can still suffer if the Federal Reserve (Fed) hikes rates too fast. Last year is the best example.

After volatile U.S. equity markets last year and low inflation, many believe the Fed may take a softer course this year. This may come as good news to EM equities, which currently have attractive valuations after taking a hit in 2018.

So, is this the right time to allocate to EM equities?

The answer is nuanced: when investing in EM, investors may want to focus on countries with higher economic growth and apply smart security selection to select stocks within those markets.

Fast Economies Lead to Faster Corporate Growth

Below, we look at ex-state-owned enterprises (ex-SOEs), both large and small caps, to identify places where maximum growth has happened. We define any company as ex-SOE where the state has less than 20% ownership. Our goal is to identify growth and profitability with minimal state interventions.

The first chart below is the proportion of large-cap ex-SOEs (market cap greater than $2 billion) that show book value growth of more than 50% over the last five years. The second chart is the proportion of small caps (market cap less than $2 billion) ex-SOEs with positive cash flows over the last five years.

country wise percentages of small cap and large cap

A quick observation: Indian, Chinese and Taiwanese companies consistently fared better across large and small caps. Next, let’s look at what may have helped these companies.

Economic Growth Feeding Corporate Growth

To explore one reason why certain countries did better than others, look at a simple chart of gross domestic product (GDP) growth trends projected by the International Monetary Fund.

GDP Growth Rates (Past and Projected)

GDP Growth Rates_Past and Projected

If you juxtapose this chart with the corporate profit growth above, there are two takeaways: 

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