India's Stock Market Faces Largest Net Sell-off Last Week
In recent months, the Indian stock market, which had enjoyed unprecedented growth, appears to be entering a period of decline. According to reports from Morgan Stanley, over the past three years leading up to the first quarter of this year, the Indian stock market surged an impressive 46%. This far outpaced the global average of 20% during the same period, while emerging markets at large saw a downturn of 13%. Only the U.S. stock market managed to match India's remarkable performance.
However, a significant shift has occurred. Data from the Securities and Exchange Board of India (SEBI) reveals that in the last week alone, foreign funds experienced their largest net sell-off since January 1, 1999. On a single trading day, October 3, foreign funds sold off a staggering $1.85 billion (approximately ₹155.4 billion) worth of Indian stocks, setting a new record for the highest net outflow. Additionally, on that day, there was a net sell-off of $101.7 million (about ₹8.5 billion) in Indian bonds. Outside of the trading holiday on October 2, foreign investment pulled out a total of ₹271.42 billion from the Indian stock market during the period from October 1 to 4.
Nikhilesh Kasi, a trader from Goldman Sachs focused on the Indian market, noted that one question dominating client inquiries has been whether capital was flowing from India to China. His answer was clear: “Yes.”
A seasoned investment banker on Wall Street shared insights with First Financial Journal, stating that both India and the U.S. markets are at risk of bubble bursts, while the Chinese capital market is severely undervalued. Thus, in light of China's recent policy changes, there is a growing tendency for capital to flow into Chinese assets from India. Large sums of money from the Indian market are increasingly being redirected towards opportunities in China.
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The mass exodus of foreign capital has led to a pronounced correction in the Indian stock market. The Nifty index fell by 4.5% last week, marking its worst weekly performance since June 2022, and continues to drift away from the record high closing point of ₹26,216.05 achieved on September 26, and the intraday peak of ₹26,277.35 recorded on September 27. However, despite this recent trend, foreign funds have cumulatively invested ₹734.68 billion in Indian stocks throughout the year, alongside an investment of ₹11 billion in bonds. Except for January, April, and May, foreign investors have been net buyers of Indian stocks consistently.
Prashant Srivastava, an analyst at Morningstar, attributes the recent foreign withdrawal from the Indian stock market to several factors, including escalating geopolitical tensions, significant rises in oil prices, and improved performance in the Chinese market, which now offers more attractive valuations.
The Wall Street banker also highlighted that the Chinese stock market has recently experienced its largest growth since 2008, increasingly capturing global capital's attention. More U.S. traders are now fixated on China's after-hours trading. During China's National Day holiday, they have been watching the movements of Hong Kong stocks closely to ensure they do not miss out on potential gains. Some traders on Wall Street believe that the prior increased allocation to the Indian stock market may have been mismatched, as India’s economic growth fundamentals were overvalued by the market.
Edward Chancellor, a global strategist with GMO Investment Management, points out a couple of grave mistakes investors often make in emerging markets. Firstly, there is a common misconception that economic expansion correlates positively with stock market returns, leading investors to be mesmerized by GDP figures without sufficient evidence. Secondly, many investors wrongly assume that valuation is a reliable predictor of returns. Since the 2008 financial crisis, India's strong performance compared to China has proven this perception to be misguided.
Data from Lyxor Securities shows that between 2014 and 2023, the return on equity (ROE) for Indian companies has remained stable between 10% and 13%. Furthermore, since 2014, the number of stocks in the MSCI China index has increased 2.5 times, while earnings per share (EPS) have experienced little change, resulting in valuations declining from over 2.5 times book value in 2020 to about 1.3 times earlier this year. In contrast, the price-to-book ratio in the MSCI India index jumped to 4.5 times from an average of over 3 times in the previous ten years. Such stark comparisons indicate that, should macro monetary policies remain supportive, Chinese assets have a more reasonable growth potential compared to their Indian counterparts.
The analyses carried out by market experts shed light on a clear trend driving foreign capital away from the Indian stock market – a desire to purchase Chinese assets. Chancellor asserts that according to the flow data provided by Goldman Sachs, this trend is markedly visible; “the fierce buying in the Chinese market has rendered the Indian market increasingly vulnerable. Foreign institutional investors are selling off their most liquid assets to extract maximum liquidity in the shortest possible time, and this fresh capital is flooding into the Chinese market.”
This trend is not confined solely to the atmosphere around the Indian markets but is equally apparent within the U.S. stock market. The premiums on short-term options for ETFs linked to China traded in the U.S. have recently reached record highs. Specifically, the iShares China Large-Cap ETF observed its one-month call options and put contracts priced at the highest levels since 2008. The implied volatility for related ETFs has also surged, with the Xtrackers Harvest CSI 300 China A-Share ETF seeing its implied volatility soar to new heights. Likewise, the iShares China Large-Cap ETF and KraneShares CSI China Internet ETF have observed significant increases in the past two weeks, ranging from 30% to 50% in gains.
A long-time U.S. retail investor in U.S. stocks is contemplating the purchase of A-shares immediately after the announcement of related policies in the Chinese market. However, due to having not traded A-shares in a long time, he forgets his account information and decides instead to trade U.S. listed Chinese stocks and ETFs. A friend of his is doing the same, opting for short-term call options on Chinese stock ETFs during China's National Day holiday while keeping a close eye on Hong Kong stocks.
This strong bullish sentiment towards Chinese stocks is not limited to retail investors; it has now become a consensus among Wall Street institutions. On October 5, Goldman Sachs notably upgraded its outlook on the Chinese stock market to “overweight,” projecting further gains of 15% to 20%. They have raised the target price for MSCI China from 66 to 84 and for the CSI 300 index from 4,000 points to 4,600 points based on forward valuations of 12.0 times and 14.2 times, respectively, up from previous projections of 10.5 times and 12.8 times.
The analyst team at JPMorgan Chase, led by Katherine Lei, recently published a report suggesting opportunities still prevail within China’s financial sector, anticipating that brokerage stocks would continue leading the market. JPMorgan asserts that, despite experiencing several rounds of impressive growth, Chinese financial stocks still appear undervalued. Compared to peak levels reached in 2020 and 2021, Chinese financial stocks are selling at a 39% discount regarding price-to-book ratios, and a massive 65% discount relative to peaks achieved in 2015. Similarly, Morgan Stanley is optimistic about brokerage stocks, stating that if investors consider the recent high average daily trading volume as the norm, these stocks could propel to significant short-term gains. “If momentum remains robust, retail investors may perceive a trading volume of 2 trillion yuan (the average daily turnover preceding the A-share market closure) as a sustainable pace, which might enable brokerage earnings to rise by another 30%, with ROE potentially hitting around 13%,” the firm explained. Goldman Sachs similarly upgraded its ratings on insurance and other financial stocks, predicting enhanced activities in China’s capital markets and sustained improvement in asset performance.