China and India Will Keep Moving Up

09/27/2010 10:05 am EST


David Fuller

Global Strategist and Producer, Fullermoney

Chinese stocks could rally once offerings abate, while India is on the move despite its self-doubts, write David Fuller and Eoin Treacy of Fullermoney.

The lull in China's stock market performance is all about supply, not the economy and certainly not valuations. The impact of this supply has changed valuations, and it does not fall equally across all indices.

Much of the supply concerns huge initial public offerings (IPOs), mainly by banks. China provided a very strong monetary stimulus for the economy following the 2008 crash, [but its] economy experienced no worse than a temporary period of slower GDP growth before rebounding strongly once again.

[But] too much of the excess stimulus went into property speculation. Determined to rein this in, China raised reserve requirements for banks, so that they could pass a stress test based on a hypothetical decline in property prices of 60%. The only way banks could do this on schedule was by very large, world-record public offerings of stock.

This supply is responsible for the banks’ underperformance. Bank shares also have a significant weighting in the Shanghai Composite Index. Additionally, the government has released more A-Shares (originally, all companies were government-owned) which were not previously tradable. The particularly heavy supply from bank IPOs and also government-held A-Shares has been evident since July 2009. These latter offerings are released by schedule, and the quantity [will decline] sharply following November 2010.

The benefit for [investors] interested in buying China today is that valuations are much more reasonable. Forward multiples are estimated at closer to 11x. It has paid to buy China at these historic multiples. Hong Kong’s Hang Seng Index and the Hang Seng China Enterprises Index have not been weighed down by supply to anywhere near the same extent, and I think performance will improve in line with the global trend.

[Meanwhile,] it has often been our experience, giving interviews to Indian financial TV channels, that there is a reluctance to accept the reality that many foreign investors regard India as one of the best long-term investment destinations. This is often manifested in questions centering on when we think foreign direct investment will be withdrawn when rather the opposite is occurring: Foreign capital is increasingly being attracted to India and provided the trajectory of reform (albeit starting from a low base) remains positive, this is likely to continue.

The Indian government bond market suggests that inflation remains a concern for investors, but with interest rates rising, a stronger currency, and a reasonably good monsoon, price pressures should start to ameliorate in the not-too-distant future.

The Sensex shares the common theme of outperformance among consumer, health care, and banking sectors with some of its better performing Southeast Asian neighbors and is currently engaged in an impressive catch-up move.

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