Brokerage firm CLSA has decided to reverse its earlier move from India to China, citing increasing concerns over China’s economic outlook and investor sentiment. This decision follows a significant outflow of Rs 1.2 lakh crore in foreign institutional investor (FII) investments from India in recent months, which has impacted the Indian market.

CLSA highlights that Chinese equities have faced several setbacks, describing it as a "misfortune in threes." The firm points to the resurgence of trade tensions, particularly in a "Trump 2.0" scenario, which could escalate the trade war at a time when exports have become a key driver of China’s economy. CLSA believes this could exacerbate the challenges facing China’s market.

In addition, CLSA views the stimulus measures announced by China’s National People’s Congress (NPC) as insufficient for stimulating growth. The firm notes that the NPC stimulus amounts to "de-risking with little reflationary benefit." The rising U.S. yields and inflation expectations further limit the ability of both the U.S. Federal Reserve and China’s central bank, the People's Bank of China (PBOC), to ease monetary policy effectively.

CLSA also raises concerns that these factors could cause offshore investors, particularly those who invested after the initial PBOC stimulus in September, to pull back from China. In contrast, CLSA believes that India is better positioned. The firm notes that India is less exposed to trade tensions, especially given the uncertainty surrounding U.S.-China relations. "India appears as among the least exposed of regional markets to Trump’s adverse trade policy," CLSA said.

CLSA also sees India as a potential safe haven for foreign exchange stability, assuming energy prices remain stable, despite the strengthening U.S. dollar. Despite strong net foreign selling in India since October, the firm observes that domestic demand remains resilient, helping to offset foreign jitters. CLSA further points out that while India’s market valuation remains high, it has become "a little more palatable" for investors, many of whom are waiting for a buying opportunity to address their underexposure to the Indian market.

However, CLSA does caution about potential risks for India. The firm highlights a surge in market issuance, which could pose a challenge for the Indian equities market. "Cumulative 12-month issuance is 1.5% of market cap," CLSA warned, adding that this level is nearing a historical tipping point that could affect market performance if demand does not keep pace with the influx of new shares.

Initially sceptical about the longevity of the China equity rally, CLSA deployed funds into China at the start of October. However, after a correction of approximately 10% in both MSCI China and India in U.S. dollar terms, the firm now reflects cautiously on that move. "Both MSCI China and India have corrected by c.10% in U.S. dollar terms over the duration, so we did not lose on making the switch," CLSA explained.

CLSA’s new strategy now involves increasing its investment in India by 20%, as it believes China’s economic outlook has become more uncertain.

In explaining its increased focus on India, CLSA notes that while valuations in China are no longer as attractive, they still offer a discount compared to other emerging markets. China is now trading on a cyclically adjusted earnings multiple of 12.0x, up from 9.2x in early September and 8.2x at the start of the year. While still a discount to other emerging markets, which trade at a CAPE of 14.0x, this gap is not as extreme as the 36% discount in early September.

Furthermore, CLSA points out that China’s market-implied equity risk premium stands at 9.8%, which is now at the post-January 2022 average, down from 10.8% in early September. This is just below the highest-ever risk premium placed on Chinese equities by the market since 2006. On asset-based multiples, China has seen some rerating relative to emerging market peers, now trading at a 20% price-to-book discount compared to the 30% discount in September, while maintaining a similar level of profitability (ROE of 11.0% for China versus 11.6% for emerging markets overall).