CLSA shifts focus back to India, cuts China exposure

Global brokerage firm CLSA has reversed its early tactical shift from Indian equities to Chinese stocks, and has decided to raise India allocation while cutting exposure to China.

In its report titled 'Pouncing Tiger, Prevaricating Dragon', CLSA cited challenges facing Chinese markets in the aftermath of Donald Trump's victory in the US elections as the reason for the move.

"Misfortune can happen in threes. So it has played out for Chinese equities over the past week.

"Trump 2.0 heralds a trade war escalation just as exports become the largest contributor to China's growth," the brokerage said.

Stating that it was sceptical on the endurance of the China equity melt up from the outset, CLSA said yet it committed a little more at the start of October by tactically deploying some of its over exposure to India towards China.

It had reduced its Indian overweight to 10 per cent from 20 per cent and raising our China allocation to a 5 per cent overweight from the benchmark.

"We now reverse that trade," it said.

The reversal comes even as India faces sustained foreign investor outflows.

Foreign institutions have sold a net Rs 1.14 lakh crore of Indian equities since October amid weak second quarter earnings and rising inflation.

CLSA said several global investors it engaged with have been waiting for such a correction to address their underexposure to Indian equities.

On the other hand, China's economic struggles include deflationary pressures, sluggish real estate investment, and high youth unemployment.

China faces prospects of higher tariffs under the Trump administration amid a precarious domestic situation that is a blend of deflation, falling property prices, rising youth unemployment, poor household confidence, stagnant real estate investment and growth in real retail sales at half the pre-pandemic rate.

"By contrast, India appears as among the least exposed of regional markets to Trump's adverse trade policy.

"Moreover, so long as energy prices remain stable, India may offer a relative oasis of FX stability in an era of a strengthening US dollar," it said.

Domestic appetite remains strong, offsetting foreign jitters, and valuation, though pricey, is now a little more palatable.

Both MSCI China and India have corrected by 10 per cent in US dollar terms over the duration so CLSA did not lose on making the switch.

"The chief risk to Indian equities is a frenzy of issuance swamping the market -- cumulative 12 month issuance is 1.5 per cent of market cap, a historical tipping point," it said.

CLSA had in October 2023 upgraded India, moving from 40 per cent underweight to 20 per cent overweight citing a favourable credit environment, lower energy costs due to discounted Russian crude, and strong GDP growth prospects. However, a year later, CLSA adjusted its strategy, reducing India's overweight to 10 per cent, while adding to China amid what appeared to be early signs of a market recovery in the dragon nation.

That position has now been changed.

Robert Lighthizer, Trump's protectionist US Trade Representative from his previous administration, has been re-designated to assume the same role in the next cabinet.

Lighthizer and Trump have been unequivocal during the presidential campaign in their wish to implement a punishing tariff schedule (60 per cent or above) on Chinese goods imports.

"In comparison, India appears as the most insulated market on this framework, benefitting in this case from relatively low trade exposure with the US, manageable leverage and a particularly low level (and declining) in foreign equity ownership," CLSA said.

In addition, it is likely that US investment flows would continue to diversify away from China under a Trump administration as 'China plus one' strategies continue to formalise.

India, it said, remains sensitive to energy prices (86 per cent of the country's oil consumption is imported, 49 per cent of natural gas and 35 per cent of its coal needs).

"We remain concerned about the potential for risk premium in the oil price or at worst, a substantive supply interruption from Iran-Israel tensions."

Importantly, the RBI has managed to accumulate a veritable war chest of foreign exchange (FX) reserves (some $700 billion worth) which it actively deploys for FX intervention in defence of the rupee.

"India is one of the few emerging markets where a relationship between corporate earnings growth and the changes in the pace of economic output holds true, attributable to the country's more domestically oriented equity market," it said.

Stating that the strong domestic retail appetite offsets foreign jitters, the brokerage said Indian equities are 83 per cent domestically owned, the highest such proportion across emerging markets.