The portfolio manager’s view
Claus Born, senior client portfolio manager, Franklin Templeton
Despite the recent correction, the valuation level of the Indian equity market remains high. The MSCI India index is trading at 24 times expected earnings, which is slightly above the level of the S&P 500 at around 23 times.
The valuation level of MSCI India is about 10-15% above the average of the past 10 years. This can be explained to a large extent by a lower cost of capital and stronger earnings growth in the Indian market. We therefore see hardly any significant overvaluation in the large-cap segment.
However, the situation is different for mid caps – this market segment currently has a valuation level that is around 100% above the 10-year average. For small caps, the valuation level is still 50% higher than the average.
In these two market segments, higher valuations were justified due to higher earnings growth.
However, we are now seeing a tendency towards an adjustment in earnings momentum. This creates the risk the valuation premiums for many small and mid caps will not be sustainable over time.
Are the outflows in India related to China’s stimulus-driven economic policy? There have certainly been investors who have tactically repositioned themselves in response to the Chinese government’s announcements.
In October, there were strong inflows into ETFs investing in Chinese equities, among other things. Until then, positioning in China had been rather weak. The announcement of economic stimulus measures has brightened investor sentiment on the country, both abroad and in China itself. But overall, the market also experienced a correction in October.
With regard to the role played by the central bank’s current policy, in October, the Indian central bank left the reference interest rate unchanged at 6.5%. Interest rate cuts are still expected over the next few quarters. The timing of these depends on how quickly seasonal inflation in food prices subsides over the next few months.
The strategist’s view
Mohammed Zaidi, investment director, Nikko Asset Management
These two markets could not be further apart in starting points and valuations. While the September-October reversal of this trend was abrupt, many things would likely need to change for sustained, long-term improvement in Chinese versus Indian equities.
India is one of the richest sources of sustainable returns and fundamental change, but finding these opportunities at a good price is the challenge. Fortunately for patient investors, such an opportunity may be emerging. Narendra Modi’s re-election to rule by coalition rather than majority likely limits his ability to implement more significant structural reforms.
Compared with other Asian economies, the Reserve Bank of India and Securities and Exchange Board of India have been proactively regulating their markets, likely curtailing growth in some areas. Additionally, the digitisation of the economy is profoundly impacting traditional distribution and brand moats –something several companies benefited from for decades.
Given its lofty starting point, some consolidation in local equity markets would be welcome. Despite some short-term reservations, India remains one of Asia’s most compelling long-term investment opportunities.
For China, our attention shifts west. US president elect Donald Trump successfully campaigned on protectionism, with China as a key target. However, assumptions this is net negative for emerging and Asian markets is uncertain. During Trump’s first term, Chinese equities outperformed the S&P 500 and all perceived China beneficiaries.
The key takeaway is Trump is not the only fundamental change. In China’s case, domestic policy is paramount. We believe Chinese equities already factor in a much higher risk premium for trade disruptions.
While China’s policy shift is towards stabilisation and addressing key financial systemic risks, sustained improvement in Chinese equities is likely contingent on greater promotion of both consumption and services – areas that would stimulate job creation, innovation and consumer confidence.
The wealth manager’s view
Kamal Warraich, head of fund research, Canaccord Wealth
In October, there was the largest monthly outflow of capital from Indian equity funds – over $10bn (£7.9bn) – since the pandemic. This was down to a combination of global and domestic factors.
Investors were taking advantage of China’s economic stimulus measures and relatively low Chinese equity valuations, which prompted a shift in capital from India to China. The Hang Seng’s price-to-earnings ratio was notably lower than India’s Nifty 50, making Chinese markets more appealing.
Another contributory factor was the overvaluation of Indian equities, with the Nifty 50 trading at high price-to-earnings multiples versus other emerging markets, meaning a sell-off was likely.
Rising US bond yields was another factor, leading to reduced expectations for aggressive Federal Reserve rate cuts, which encouraged investors to redirect funds to US assets, seen to be safer.
There have also been geopolitical concerns, with ongoing tensions in the Middle East and Ukraine. This contributes to the narrative of a cautious outlook on global growth, meaning investors want less exposure to emerging markets like India. And the picture for Indian markets has been a little bleak, with a lacklustre Indian corporate earnings season dampening investor confidence.
At Canaccord Wealth, we are still marginally overweight India and underweight China within our emerging market allocation. We do not allocate on a country-specific basis across emerging markets, which is a bottom-up result of our broader equity strategy that seeks to maintain a bias towards high-quality funds and companies.
Although China’s appeal to some foreign investors might be growing, we remain cautious. The Chinese stockmarket is still frowned upon by a lot of global investors due to the political overhang, which cannot be overstated.
Of course, we are aware of the considerable discount many Chinese companies trade on and are keeping watch.
The fund selector’s view
James Sullivan, head of partnerships, Tyndall Investment Management
China and India, the two principal protagonists of the emerging market index, are hard to ignore, and a little like that famous yeast extract, investors tend to love or hate them depending on the economic cycle.
There is little doubt that the emerging markets index is both absolutely and relatively cheap, but that is more to do with China than it is India.
India trades at 22x trailing earnings compared with the index at less than 14x. India has eased back a little in terms of valuation, but the valuation remains one that is closer to fully priced than opportunistic.
Despite the Chinese equity market appearing to offer good value, it is still too reliant on policy measures akin to a defibrillator bringing a patient back to life; until the Chinese equity market is discharged from hospital, it remains ‘touch and go’ as to whether it will be able to sustainably support itself any time soon.
All things considered, not least the direction of travel for the US dollar, for the same or better risk premium, we’d rather have any excess allocation to cheap developed markets than emerging markets at this moment in time.
This leaves us with a position that is typically ‘in line’ with our benchmarks, using a blend of active and index funds to source the exposure we require. Vanguard is currently our preferred index fund in this space, paired with broader Asia Pacific active funds such as Stewart Asia Pacific Leaders and Jupiter Asian Income where a higher yield is required.
This article first appeared in the December issue of Portfolio Adviser magazine