How to Ride the Elephant

By William Green

Not so long ago, there was no surer way to get rich in a hurry than to bet on Indian stocks. Millions of Indians were finally clawing their way into the middle class, creating a new domestic consumer market, while companies in Bombay and Bangalore emerged as global players in everything from outsourcing to pharmaceuticals. Investors went crazy. India's main stock index, the Sensex, has more than tripled in the past three years. One giddy investing show on Indian TV has even dubbed itself Sensex and the City.

How hot has India been? Foreign institutional investors poured $30 billion into the Indian market in three years--double the amount they had invested in the previous decade. Firms like JP Morgan and Fidelity raced to set up India-focused mutual funds. An Indian student at Harvard Business School told TIME that one of the U.S.'s best-known hedge funds had given him $5 million to invest in Indian stocks--never mind that he hadn't yet graduated. "The joke going around was that if you had an Indian girlfriend when you were at college in Boston," says Manish Chokhani, director of Enam Securities, one of India's biggest brokerage firms, "you could have stood on a street corner and raised $200 million to invest in India."

But for investors, much of the fun has stopped. After peaking in early May, the Sensex plunged 30% in a matter of weeks, at one point tumbling 10% in just two hours. "It feels like the hangover after a big party," Chokhani says. Indian stocks rallied dramatically late last week, but for U.S. investors eyeing this mayhem from afar, the Indian market looks as risky as it is tempting. With stock prices down, is this the moment to invest on the cheap in what many believe will be the world's fastest-growing economy over the next 50 years?

Before you wade in, remember that the carnage could get a whole lot worse. Like many markets, India has been badly rattled by fears that the U.S. Federal Reserve and other central banks will keep raising interest rates to fight inflation. That could cause global economic growth to slow precipitously--a worry that's causing edgy investors to pare their exposure to Indian stocks. Marc Faber, a renowned emerging-markets investor based in Hong Kong and Thailand, expects a further fall in the next six months as that uncertainty deepens. "In the near term, you have to be cautious," he warns.

Yet the long-term picture remains sunny. "It's like China maybe 15 or 20 years ago," Faber says. A frequent visitor to India since the early '70s, Faber says Bombay alone has changed more in the past four years than in the previous 30, with the sudden emergence of chic restaurants, hotels and stores as the most visible signals of India's new sense of wealth and optimism. And gaps in development provide opportunities for growth. India's infrastructure and housing are ripe for improvement, says Faber, and there's enormous scope for the building of malls and supermarkets.

India also has a younger population than any other major country. According to Ridham Desai, Morgan Stanley's head of Indian equities research, about 125 million Indians will join the workforce in the next decade, and they will be key to the country's growth. Foreign firms will hire legions of them to drive down costs, and their prosperity will fuel demand for stylish clothes, cars and other baubles. Thanks to this demographic advantage, "India will grow faster than the rest of the world," says Desai.

The question for investors is how richly to pay today for a stake in companies that will profit from these trends in the future. The Indian market trades at a 20% premium over other emerging markets, making it too pricey to jump into now, says Adrian Mowat, JP Morgan's chief Asian equities strategist. Jon Thorn, a portfolio manager at India Capital Fund, disagrees. "The long-term case for investing there is without question the best in the world. I'm going around to all my investors saying, Now is the time," Thorn says. "You need to buy when there are moments of panic." Savvy investors, he says, should stash some of their assets in Indian stocks or funds for the long haul. Faber is even more bullish. "If someone put a gun to my head and said, 'You have to put all your money in India or all of it in the U.S.,'" he says, "I'd choose India."