BNP Paribas is recommending its clients to reduce their exposure to China, which it has lowered to neutral from overweight, and increase their allocations to India, where the bank remains overweight. It is raising its target for the Bombay Stock Exchange Index (Sensex) to 16,500, representing a price-to-book value (PBV) of around 3.2 times earnings for 2009.
Three factors drive BNP Paribas' switch recommendation: valuations, flows and liquidity are turning more favourable in India relative to China; India has a higher exposure relative to China in the sectors that the BNP Paribas favours at this point in the cycle; and the external funding environment, which is crucial for delivering proposed infrastructure investment, is turning more favourable for India
"The China equity market has been underperforming MSCI Asia ex-Japan by 5% since the March low, reflecting in part the stellar performance from the cyclical low recorded in late October 2008 through the end of February. Unlike other markets in this region, China is yet to see any major upward revision to earnings," says BNP Paribas in a report.
Although India has disappointed investors because of May earnings revisions, BNP Paribas believes the INC-UPA coalition win and a dramatic improvement in the international liquidity environment will result in a sharp turnaround in the earnings revisions cycle in June and investors are discounting such an outcome in advance.
Among the three factors BNP Paribas cites in favour of India, the assertion that China shares are less attractive in terms of valuations is subject to interpretation.
According to BNP Paribas, MSCI India trades on a PBV of around 2.8 times earnings for 2009 compared with 2 times for MSCI China and 1.7 times for MSCI Asia ex-Japan. However, the bank believes India deserves to trade at a higher PBV because of its higher return on equity (ROE). BNP Paribas says India's ROE is the second highest in the region at 22% (Indonesia is the highest at 28%), while China's ROE is 17%.
The ROE of Indian companies is also more sustainable than that of Chinese companies, BNP Paribas notes. India's share of regional fund flows has moved up a notch following the government elections, with the market capturing 31% of the total weekly flows for the Asia six (Taiwan, Korea, Thailand, Indonesia, Philippines and India). This compares with India's record of accounting for almost half the region's outflows during the dark days of February. While the Asia six weekly flows data does not include China, data from Massachusetts-based data provider EPFR Global on US mutual funds highlights a slump in China inflows from more than $1 billion a week in the first quarter to a mere $18 million in the last week of May.