Is China’s stock market rally behind Indian equity losses?

This report is from this week’s CNBC’s “Inside India” newsletter which brings you timely, insightful news and market commentary on the emerging powerhouse and the big businesses behind its meteoric rise. Like what you see? You can subscribe here.

China’s CSI 300 index has gained about 25% since the stimulus measures were announced. Meanwhile, India’s Nifty 50 has fallen by more than 3.5%. Seven of the past 10 trading days have been losers for Indian equities, while China stocks have risen every day except one, according to CNBC’s count.

The causal link between the two equity markets over the past two weeks raises the question of whether stellar returns in India have come at the cost of falling Chinese asset prices over the past four years. More importantly, could this reverse in the near future?

In the short term, there appears to be some evidence linking China’s gain to India’s losses. Citi strategists cautiously observe that “when there were significant outflows from China, we have seen a similar pick up in inflows to India”.

“While fund flows are fungible and it’s difficult to attribute the direction of flows, we would not be surprised if investors begin taking profit from overweight India positions to fund closing China underweight positions,” said Chris Ma, head of Asia quantitative research at Citi.

In addition, Berstein’s Rupal Agarwal downgraded India to “Underweight” while maintaining the investment bank’s “Overweight” stance on China, saying, “On India, we have been neutral, but now we find the market to be quite vulnerable in the near-term driven by record high relative valuations to China and EM (already showing signs of peak)”.

Could there be further pain for Indian equity investors if more of the rumored stimulus measures are confirmed? That would depend on whether the measures announced will likely target China’s stock market or the real economy.

Although stimulus measures have boosted stock prices so far, JPMorgan’s equity strategist David Aserkoff pointed to his investors that the rally may have its Wile E. Coyote moment if the underlying economic environment remains challenging.

“The problem for [Central and Eastern Europe, the Middle East, and Africa] equities is if these new/improved swap facilities just boost Chinese stock purchases and if the economic stimulus does not boost Chinese economic growth, then where is the upside for CEEMEA stock markets? We do not see it,” Aserkoff said the day after the stimulus measures were announced.

Similarly, Morgan Stanley’s strategists suggest that the MSCI China index is expected to be “range-bound” in the second half if no further policy measures are announced.

Even if China’s economy improves and its stock market soars, experts suggest it’s unlikely to hurt the Indian equity market’s growth outlook over the long term.

For now, a strong and rapidly growing economy, as well as a “resilient” domestic investor base, continue to be significant drivers of Indian stock markets, according to Wall Street’s observers.

“The Indian market has numerous positive domestic drivers which underpin our overweight recommendation,” Morgan Stanley’s Jonathan Garner said in a note to clients this week. “These include sustained high real and nominal GDP growth and earnings growth and the best demographic underpinning for equities demand in our coverage.”

Citi strategists also echoed a similar view, adding, “We remain constructive and would buy any dips.”

— CNBC’s Michael Bloom contributed reporting.

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Meanwhile, the India market is “purely a fundamental story,” said James Thom, senior investment director at Abrdn. That is in contrast to the Chinese market, which is driven more by sentiment than fundamentals, he said. “We’ve seen robust economic growth that is filtering through earnings growth,” Thom told CNBC. While the valuations of Indian stocks are high, Thom does not think there’ll be a material de-rating because “trajectory, fundamentally, is very sound.”