China and India reveal emerging market mistakes
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
By Edward Chancellor
LONDON, Oct 3 (Reuters Breakingviews) -Investors make two profound errors in their approach to emerging markets. First, they are entranced by GDP growth even though there is no evidence of a positive correlation between an expanding economy and stock market returns. Second, they assume that valuations are a reliable predictor of returns. The strong outperformance of Indian stocks relative to Chinese equities since the financial crisis of 2008 shows how wrong this approach has been.
The very word “emerging” suggests that less-developed economies with strong growth prospects can be expected to deliver superior investment returns. Let’s see how that turned out. Over the past 15 years, the Chinese and Indian economies have both grown rapidly. China’s GDP expanded by roughly 2% a year more than India’s, when measured in constant U.S. dollars. Back in September 2009, the price-to-earnings multiple of the MSCI China Index was 25% lower than for MSCI India Index. Yet despite starting out cheaper and experiencing faster economic growth, the Chinese stock market since 2014 has delivered total annual returns of just 2.5% in dollar terms. Indian stocks have compounded annually by four times that amount, according to Jefferies.
There’s a relatively simple explanation for this divergence. In late 2008, the Chinese government in Beijing launched a huge stimulus to stave off the global financial crisis. It used the country’s vast domestic savings to finance an extraordinary investment boom. Gross domestic fixed capital formation soared from 38% to 44% of GDP and has remained elevated. The investment splurge was accompanied by rapid credit growth and supported by easy money. By contrast, India had relatively low savings and investment. Between 2009 and 2020, investment fell from 34% to 27% of GDP. Indian interest rates on average were twice as high China’s.
Economic theory posits that the return on capital should eventually equal its cost. Sure enough, China’s low cost of capital has delivered meagre returns. Capital has been misallocated on a grand scale, as evidenced by chronic levels of excess capacity across the economy. Since its housing bubble burst in 2020, the People’s Republic has been beset by debt deflation. India enjoyed no real estate, credit or investment boom and thus avoided the ensuing hangover. Its relatively high cost of capital produced relatively high returns on investment.
This macroeconomic analysis is evident in the reports and accounts of listed Chinese and Indian companies. One gauge of whether a company is investing prudently is the ratio of new capital expenditure to depreciation on past investments. Gillem Tulloch, founder of Hong Kong-based GMT Research, has examined the returns of Chinese and Indian companies which have a minimum of 10 years of data, which equates to about a quarter of the listed firms in both markets. In 2014, the average capex for Chinese public companies was 2.3 times depreciation. The ratio for their Indian counterparts was considerably lower, at 1.5 times. Since then, Chinese firms have consistently invested more than their Indian counterparts.
A key component of profitability is measured by the ratio of a company’s sales to its total assets. More efficient businesses have a higher level of asset turnover. Tulloch finds that this measure in India averaged around 1 times over the past decade. The average Chinese company, on the other hand, recorded sales relative to its assets of half that level. As a result, the return on equity (ROE) of Indian companies between 2014 and 2023 remained stable in the range of 10% to 13%, while the average ROE in China fell from 10% to 6% over the same period, according to Tulloch.
Since investment returns have lagged economic growth, Chinese firms have had to raise more capital, thereby diluting existing shareholders. The total number of shares in the MSCI China Index has increased by 2.5 times since 2014, according to CLSA. Yet earnings per share have scarcely budged. Investors have taken notice. The valuation of the Chinese benchmark has declined from over 2.5 times book value in 2020 to 1.3 times earlier this year. Meanwhile, the price-to-book ratio for MSCI India Index, which averaged just over 3 times over the last decade, has risen to 4.5 times.
Alex Duffy, an emerging markets specialist at Marathon Asset Management, argues that India’s capital discipline is starting to break down. Indian companies are currently adding new capacity across a variety of sectors, including steel, cement and power generation. Jefferies expects India’s investment share of GDP to rise from a low of 28.5% to 33% over the next three years. High stock market valuations have attracted a flood of initial public offerings. Private investment funding by banks and other financial institutions has nearly doubled since 2022, according to Jefferies.
Retail investors have helped to push the valuations of Indian midcap stocks to 35 times forecast earnings, a 70% premium to their long-term average, with no discernible improvement in growth rates or underlying profitability, says Duffy.
While India’s stock market is showing signs of a speculative blow-off, China’s capital cycle may be approaching a trough. Chinese companies’ capex to depreciation ratio has dipped to 1.5 times, in line with Indian levels, according to Tulloch. Private market capital raisings are down 98% from the pre-Covid-19 period, says Duffy. The securities regulator has instructed listed firms to increase their distributions to shareholders. Share buybacks now account for nearly 40% of total payouts. As stock repurchases have risen, the number of outstanding shares has started to fall, according to CLSA. In principle, a declining share count should boost growth in earnings per share.
Since Beijing unveiled a new stimulus package last week, Chinese stocks have been on a tear. The People’s Bank of China promises to provide loans for companies to repurchase more shares. That’s not enough. Chinese industry needs to remove excess capacity, says Duffy. It’s unclear whether President Xi Jinping has got the message. Chinese investment may have declined as a share of GDP but is still a heady 42%. Chinese stocks may still appear cheap on every valuation measure. However, until there is clear evidence of retrenchment on the supply side, emerging market investors should remain wary.
Follow @Breakingviews on X
Investment in China has been higher than in India https://reut.rs/4eqegwb
India's stock market trades at a premium to China's https://reut.rs/3zKIVoI
Return on equity in India is higher than in China https://reut.rs/3N7mMnI
Editing by Peter Thal Larsen and Streisand Neto
면책조항: XM Group 회사는 체결 전용 서비스와 온라인 거래 플랫폼에 대한 접근을 제공하여, 개인이 웹사이트에서 또는 웹사이트를 통해 이용 가능한 콘텐츠를 보거나 사용할 수 있도록 허용합니다. 이에 대해 변경하거나 확장할 의도는 없습니다. 이러한 접근 및 사용에는 다음 사항이 항상 적용됩니다: (i) 이용 약관, (ii) 위험 경고, (iii) 완전 면책조항. 따라서, 이러한 콘텐츠는 일반적인 정보에 불과합니다. 특히, 온라인 거래 플랫폼의 콘텐츠는 금융 시장에서의 거래에 대한 권유나 제안이 아닙니다. 금융 시장에서의 거래는 자본에 상당한 위험을 수반합니다.
온라인 거래 플랫폼에 공개된 모든 자료는 교육/정보 목적으로만 제공되며, 금융, 투자세 또는 거래 조언 및 권고, 거래 가격 기록, 금융 상품 또는 원치 않는 금융 프로모션의 거래 제안 또는 권유를 포함하지 않으며, 포함해서도 안됩니다.
이 웹사이트에 포함된 모든 의견, 뉴스, 리서치, 분석, 가격, 기타 정보 또는 제3자 사이트에 대한 링크와 같이 XM이 준비하는 콘텐츠 뿐만 아니라, 제3자 콘텐츠는 일반 시장 논평으로서 "현재" 기준으로 제공되며, 투자 조언으로 여겨지지 않습니다. 모든 콘텐츠가 투자 리서치로 해석되는 경우, 투자 리서치의 독립성을 촉진하기 위해 고안된 법적 요건에 따라 콘텐츠가 의도되지 않았으며, 준비되지 않았다는 점을 인지하고 동의해야 합니다. 따라서, 관련 법률 및 규정에 따른 마케팅 커뮤니케이션이라고 간주됩니다. 여기에서 접근할 수 있는 앞서 언급한 정보에 대한 비독립 투자 리서치 및 위험 경고 알림을 읽고, 이해하시기 바랍니다.
