This Emerging Market Could Go on a Major Run Very Soon

With just a quick glance, the whole “invest in India” craze appears to have run its course. India’s stock market, the Bombay Stock Exchange Sensex Index, rallied more than 200% between March of 2009 and late 2010.

Then, a rather nasty 25% pullback in 2011 doled out enough pain to make investors think twice about investing again. In fact, you could say Indian stocks are now completely out of favor.

And that’s exactly why now’s the time to start digging in…

The contrarian case
India has been one of those confusing markets recently, rewarding those who were willing to go against the grain and take on contrarian, unpopular stances.

Take last November for instance. After more than a 20% decline pulled the Sensex down to a low 15,745, beaten-up investors of India’s stocks began to seriously entertain doubts about the country’s future investment-worthiness. Darashaw & Co. analysts had projected sub-15,000 levels were in the cards, based on bearish momentum and plenty of pessimism. Not only did the Sensex Index not slide any further below 15,745, but it was back to the 18,500 area by February — a 17% rebound right when investors had all but given up.

On the flipside, in November of 2010, after the SENSEX had posted 12-month gains of 23%, traders were understandably hot on the emerging market. As a Forbes article noted that month, “Maybe it’s the right time for outside investors to seriously think about joining the India bandwagon.” Heeding the advice would have been a big mistake, as that was the beginning of a 23% sell-off.

So why does this matter now? Because the Indian market’s 6.5% dip since February once again has India’s investors worried.

There’s an edge to a contrarian/bullish stance this time around, though. Indian stock valuations are at historical lows. Indian brokerage firm Sharekhan says the current average price-to-earnings (P/E) ratio for India’s stocks right now is around 13, compared with a long-term average of 18. Historically speaking, once Indian stocks become this cheap, a 65% to 70% advance materializes over the next two to three years.

If that’s not convincing enough, then try this on for size: A hefty $9 billion worth of India’s stocks have already been purchased by overseas investors so far this year, which is more than half of the total amount of foreign investment in India for all of 2011. Clearly, investors are beginning to see the opportunity, and there’s plenty of reason for the interest.

Ways to play
#-ad_banner-#There are several ways to play such a rebound. One of them is the obvious — an Indian exchange-traded fund (ETF) like the iPath MSCI India Index ETN (NYSE: INP). But for investors who want to up the ante, so to speak, there are two standout Indian companies that trade as ADRs (American depository receipts) in the United States right now.

One of them is Tata Communications (NYSE: TCL). Tata Communications is a telecom infrastructure company that has fought its way to the front of the line for many emerging markets. In fact, it interconnects more than 200 different countries with its Tier 1 IP network. That footprint could get a lot bigger real soon, as the company has completed the world’s first wholly-owned “round the world” cable network ring.

At the same time, Tata Communications is in a position to become more effective and efficient while marketing that network. Currently, it’s a hodge-podge of several distinct telecom entities, but it began to integrate all of them in February. It’s also one of only a couple of known bidders for the United Kingdom’s telecom company Cable & Wireless Worldwide. Bringing that established entity into the fold would further bolster the Tata footprint.

The other Indian stock worth a closer look is ICICI Bank Ltd. (NYSE: IBN). Yes, though the buzz is that asset quality for India’s banks is weakening, ICICI has been seen as an exception to that norm; the state’s credit rating agency still views the organization as still worthy of its “AAA” rating.

ICICI shares trade at only about 16 times trailing earnings, compared with smaller competitors that trade at 20 times earnings or more. While those other stocks superficially seem to deserve a premium ICICI can’t justify, there is flipside to the coin. Those other banks are also highly-rate sensitive, whereas ICICI Bank drives a considerable amount of fee-based revenue. If India’s high interest rates start to creep lower, then ICICI will be standing on much more solid ground.

Risks to Consider: There’s always the possibility that political turmoil and policy changes can change the landscape of investing abroad. India is no exception.

Action to Take–>
An ETF is the easy and safe way to play India’s rebound, but the two stocks I mentioned are likely to be more potent.

If Tata Communications wins the Cable & Wireless bid, then the stock may be able to muster a 30% to 40% increase in value in fairly short order (perhaps 12 months or less), but could still do pretty well for investors even if it isn’t brought under its wing. ICICI Bank isn’t as apt to make those kinds of gains in the same timeframe, though it is still a solid play. Unfortunately, the full value is ICICI’s safer business model likely won’t be fully revealed unless and until India’s economy starts to struggle. It’s still got blue-chip-like potential in the meantime though.