The narrative on China is changing post the recent stimulus measures, and it will be hard for global investors to ignore the Chinese markets.
Recent developments -- geopolitical flare-ups in West Asia that have triggered an 18 per cent increase in crude oil prices to around $80 a barrel in just a few days, stimulus measures announced by China to prop up its economy, and the lofty valuation of Indian markets (23x one-year forward earnings) -- have prompted foreign portfolio investors to dump Indian stocks worth over Rs 30,000 crore in the first four trading days of October.
Given this context, some experts suggest that investors should avoid the Indian stock markets and consider Chinese equities instead, from a short- to medium-term perspective.
However, they do expect the underperformance of Indian equities compared to their Chinese counterparts to be short-lived.
'With renewed interest in Chinese 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 near-term underperformance of Indian equities against the broader Asia ex-Japan (AxJ) index,' analysts at Nomura noted in a recent report.
'However, this will not be a long-lasting period, as the structural story of India remains quite attractive,' Nomura analysts added.
On the other hand, BCA Research, a Canada-based research firm, suggests that absolute-return investors avoid Indian markets in light of recent developments, particularly the stimulus from China.
They believe that foreign investors will likely gravitate towards Chinese markets over the next several months, at the expense of Indian equities, given the meaningful stimulus measures implemented by Chinese authorities and the currently beaten-down level of the Chinese bourse.
'Dedicated emerging market (EM) and emerging Asian equity portfolios should downgrade India from 'neutral' to 'underweight',' wrote Arthur Budaghyan, chief EM/China strategist at BCA Research, in a recent co-authored note.
'Stay with the relative equity trade we recommended last week: short Indian equities/long Chinese A-shares,' Budaghyan added.
BCA Research also points out that credit deceleration and fiscal tightening indicate an imminent slowdown in India's economic growth.
They believe that fiscal spending, excluding interest payments, is rapidly contracting in nominal terms.
Both drivers of stock prices -- profits and (earnings) multiples -- are declining in India at a time when equity valuations are at record highs, the research firm warns.
'The credit impulse has turned negative. This will restrict both household spending and corporate investment growth,' Budaghyan said.
'Indian corporate profits will slow further as tight monetary and fiscal policies continue to weigh on firms' top-line growth and profit margins,' Budaghyan added.
Valuation frown lines
In terms of valuation, Budaghyan notes that Indian stocks are currently overvalued by two standard deviations relative to their history.
Compared to their EM peers, they are overvalued by 1.5 standard deviations.
'The extreme valuations make Indian stocks highly vulnerable to a major selloff, which could be triggered by any global or domestic trigger,' BCA Research said.
'Even a moderate profit disappointment could lead to a major downdraft in share prices.'
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Feature Presentation: Aslam Hunani/Rediff.com
