The great Indian revival has collided with the sober reality of corporate earnings.
While global investors have seized on India as the epicentre of emerging market growth and the source of lucrative returns, the great changes afoot have yet to translate into a resurgence of profits.
"Whether it's looking at companies' financial results, or in talking to the companies directly, they don't have the confirming evidence yet," said Jim Hall, chief investment officer at Mawer Investment Management. "So it's a matter of faith."
India is making great strides to unlock its untapped potential, and the stock market is bearing all the hallmarks of a good long-term investment, but investors may be wise to wait for more attractive valuations, Mr. Hall said.
Change has been long overdue for a country that largely skipped the industrialization phase of development, going directly from an agricultural economy to one based in services.
"It has a much stronger service economy than you would expect at this stage of development," said Philippe Langham, head of emerging markets equities at RBC Global Asset Management.
Still, on the strength of the country's demographic boom and urbanization, India generated enough growth to warrant inclusion among the BRIC countries as one of the most-hyped emerging market economies.
In mid-2013, emerging market sentiment reversed, coinciding with the so-called "taper tantrum," when the U.S. Federal Reserve said it would begin paring back its quantitative easing program, followed by vast capital outflows from emerging markets, including India. India found itself in an unenviable group of countries this time – the Fragile Five.
The rebound back to investor darling began at the top. The rise to power of pro-business Prime Minister Narendra Modi, combined with the central bank leadership of Raghuram Rajan, have restored global confidence in the country.
Since his election last May, Mr. Modi has taken steps to reform taxes, rein in the black market economy, encourage domestic and foreign investment and develop badly needed infrastructure.
The recent budget included large increases to spending on roads and rails, while the government wants to increase manufacturing's share of GDP to 25 per cent by 2022, from 16 per cent today.
"It's a powerful story," Mr. Langham said. "There can be no question about the government's commitment, as well as the mandate that they have."
The market responded dramatically to that story. The benchmark S&P Bombay Stock Exchange Sensex Index rose by 35 per cent over Mr. Modi's tenure to hit a record high in early March.
The investor frenzy pushed valuations to levels that didn't account for contingencies, Mr. Hall said. "It seems to be priced in – most of the good, and not a lot of risk."
The MSCI India Index trades at a forward price-to-earnings multiple of about 17.3, which is at about the peak of the previous two cycles, according to a recent Pavilion Securities note. That multiple is almost more than 30 per cent higher than the MSCI Emerging Markets Index.
But the expected spike in Indian earnings has yet to materialize. Sensex index profits fell in the fourth quarter, while fiscal 2016 earnings estimates have dropped by 4.7 per cent since the end of December, according to Bloomberg.
Investors became rattled. The index lost just shy of 10 per cent in a little more than three weeks in March, before quickly making back about two-thirds of the lost value.
Investors were only temporarily pessimistic, and have seemingly regained their faith in the pace of Indian political and economic reform, as well as in the materialization of blistering earnings growth.
Mr. Hall is going to wait for more evidence before he invests in some of the Indian stocks on his watch list. "There are definitely targets on list. But sometimes we wait for three or four years to buy a company."
Tim Shufelt