India versus China remains the single most important question facing emerging market investors, and it is becoming harder to make this choice, according to a note by Macquarie.
Following a strong 13 per cent relative rebound in the third quarter of this year, MSCI China has lost 3-4 per cent in the first two weeks of October. While it still leaves the index up more than 6 per cent versus MSCI EM Index year to date, there is a noticeable erosion in investor enthusiasm. On the other hand, India’s underperformance has subsided, and partially reversed, with overall YTD returns still in the positive territory (up 7-8 per cent).
Triple negatives
India’s equities are facing triple negatives in the form of weakening GDP growth, high earnings growth expectations (17 per cent) and historically the highest multiples of about 23x, the brokerage said. While domestic liquidity continues to build, the last two weeks have seen meaningful net foreign equity outflows of $7 billion. Despite recent erosion, MSCI India is still seating on about 70 per cent cumulative four-year outperformance.
On the other side, investors expect that China will ultimately embark on meaningful stimuli that will not only underwrite this year’s growth but also extend into 2025-26. Although few believe that China will address its deeply imbedded structural challenges, at the very least, it should be able to place the floor under nominal and real GDP, helping corporates to deliver something close to the current 10-11 per cent EPS estimates, said Macquarie.
There is a perception that the government is finally focusing on the economy, and it is likely to underplay political, geopolitical and regulatory issues. Finally, MSCI China Index remains relatively cheap (~10x), and is seating on about 35 per cent cumulative four-year underperformance.
“Under normal circumstances, it would be easy to argue that China’s recent rebound should continue. But, these are not normal times,” said Macquarie.
First, investors should not expect any meaningful global acceleration to propel China’s exports. The opposite is true, with sub-standard global growth amplified by a hostile trade and investment climate: from stagnating trade elasticities to a rising tide of tariff and protectionary measures. This is poor news for China, but India prefers a “Twilight” of not too strong or weak growth, and it is not subject to the same pressures.
“We do not view China’s recent pivot as anything more than an attempt at de-risking and underwriting growth targets, with policies remaining underpowered from consumption and real estate perspectives: moderate clean-up of local government financing vehicles and local debt, some stabilisation of real estate and minor changes in consumption and welfare spending, without addressing structural issues of high savings and reliance on investment and exports,” Macquarie said.
Labour & capital
On the other hand, India will continue to add labour and capital while growing productivity. Although 8 per cent growth is out of reach (requires higher domestic productivity and efficiency of capital), the economy should expand at 6-7 per cent, implying a steady double-digit nominal GDP growth (versus about 4 per cent for China). India’s corporates should deliver much stronger return on equities of 16-17 per cent against about 9 per cent in China.
“It is quite possible that further announcements might propel China’s equities, even as structural issues fester. But, this is mostly a trading, not an investment call, which still heavily favours India,” the note said.