Time to downgrade Indian stock markets? Sell India, buy China? Analyst view

Absolute-return investors must avoid Indian markets in the backdrop of recent developments, especially the stimulus by China, suggests a report by BCA Research

Developments over the last few weeks – flaring geopolitical conflict in West Asia that has triggered 18 per cent rise in crude oil prices to around $80 a barrel in a matter of days, stimulus measures announced by China to prop up its economy and lofty valuation of Indian markets (23x one-year forward earnings) – has seen foreign portfolio investors (FPIs) dump Indian stocks worth over Rs 30,000 crore in the first four trading days of October.

Given this, some experts suggest investors should avoid investing in the Indian stock markets and should look at Chinese equities instead from a short-to-medium term perspective. However, they do expect the underperformance of Indian equities versus their Chinese counterpart to be short-lived.

“With renewed interest in China equities on the back of recently announced monetary and liquidity measures and market expectations of more fiscal stimulus ahead, there is a rising risk of some near-term underperformance of India equities against the broader Asia-ex-Japan index (AeJ). However, this will not be a long-lasting period, as the structural story of India remains quite attractive,” wrote analysts at Nomura in a recent report.

Those at BCA Research, a Canada-based research firm, on the other hand, suggest absolute-return investors avoid Indian markets in the backdrop of recent developments, especially the stimulus by China. Foreign investors over the next several months, they said, will likely gravitate toward Chinese markets at the expense of Indian ones given the recent meaningful stimulus by Chinese authorities and the beaten down level of that bourse.

“Dedicated emerging market (EM) and Emerging Asian equity portfolios should downgrade India from neutral to underweight. Stay with the relative equity trade we recommended last week: short Indian equities/long Chinese A-shares,” wrote Arthur Budaghyan, chief EM / China strategist at BCA Research in a recent coauthored note.

Credit deceleration and fiscal tightening, BCA Research said, point to an imminent slowdown in India’s economic growth. Fiscal spending, it believes, excluding interest payments is rapidly contracting in nominal terms. Both drivers of stock prices – profits and (earnings) multiples – are headed lower in India at a time when equity valuations are at a record high, the research house warns.

“The credit impulse has turned negative. This will restrict both household spending and corporate investment growth. Indian corporate profits will slow further as simultaneously tight monetary and fiscal policies continue to weigh on firms’ topline growth and profit margins,” Budaghyan said.

Valuation woes

Valuation wise too, Indian stocks, Budaghyan said, are currently overvalued by two standard deviation relative to their own history. Relative to their EM peers, they are overvalued by 1.5 standard deviation. 

“The extreme valuations make this bourse (Indian stocks) highly vulnerable to a major sell-off, which can be caused by any global or domestic trigger. Even a moderate profit disappointment could lead to a major downdraft in share prices,” BCA Research said.

The narrative on China, according to Macquarie, is changing post the recent stimulus measures, and it will be hard for global investors to ignore the Chinese markets. China as an asset class, alongside other EMs, historically has been and still remains a macro trade and will need further cuts by the US Fed to sustain the momentum.

From an equity market standpoint, as China rallies, Macquarie believes pressure on India will rise, especially given its slowing economy and high valuations. Liquidity in this backdrop will be ‘sucked-out’. 

“Investors are giving the benefit of doubt that China will do what it takes. But, it won't be easy, with the problem being demand for not supply of money, and more radical policies are likely to run against political and social covenants. Long-term, we are still more comfortable with India's secular outlook than with China's battle against high saving rates,” said Viktor Shvets, head of global desk strategy at Macquarie Capital.