China stimulus spurs healthy mean reversion

It’s still unclear whether the Chinese government’s efforts to revive the country’s ailing economy will prove successful, but the stimulus measures already appear to be having one positive side effect: valuations in most Asian equity markets have shifted into healthier territory.
Beijing began to roll out a raft of monetary and fiscal stimulus measures in late September, including debt swaps with local governments, cuts to borrowing rates, measures to facilitate property purchases and policies to promote corporate buybacks.
While the actions designed to support the property market have yet to bear fruit, those aimed at boosting China’s equity market had an immediate impact.
China’s CSI 300 index spiked by more than 30% in a little over two weeks after the announcement of enhanced stimulus measures.
At roughly the same time, many other Asian equity markets experienced massive outflows.
In October, an unprecedented US$15 billion of foreign institutional money flew out of non-China Asian equity markets, with India and Korea accounting for more than 95%.
This has caused Asian equity market valuations, which were quite divergent until recently, to begin reverting to the mean.
This trend is best illustrated by viewing Asian equity market valuations against the countries’ respective growth forecasts.
Based on this comparison, almost all countries have moved closer to the regional trend line.
Indonesian equities have turned slightly cheaper since mid-August, while Thailand has become a little more expensive. And, most notably, China’s relative position has shifted from undervalued to in line with expectations.
India, the priciest market before the correction with a price-to-earnings ratio of 26x, experienced the most dramatic decline.
The country’s equity index, the Nifty 50, fell by 8.5% from the September 26 peak through the end of October.
While India’s equity multiple has not decreased significantly, it has moved much closer to the trend line for the region. That’s because the “re-rating” of China’s market has pushed up the average PE multiple for the region.
This mean reversion is healthy for two key reasons.
First, valuations are becoming more closely aligned with fundamentals. Chinese equities, which were arguably under-owned before September, reacted significantly to a meaningful positive catalyst. That’s exactly how markets are supposed to function.
Second, fundamentally attractive but expensive markets, such as India, saw their premiums slashed.
This should help these countries attract more foreign investors, who have become increasingly wary of investing in emerging markets at extremely high multiples.
Consider the relative equity valuations in China and India. Both markets traded at premium valuations relative to the Asia ex-Japan average over the past 15 years: China at 20% and India at 25%.
One could reasonably argue that India deserves to trade at a premium to its Asian peers: it’s the fastest-growing Group of 20 economy, has a large liquid market with a broad range of growing sectors, and has many companies that consistently generate returns in excess of their cost of equity.
The question is, how much to pay for this market? Before the correction in October, India was trading at a premium near 90%. A figure that large likely made many foreign investors cautious.
But the relative premium has since fallen below 60%.
That’s still on the high side, but the drop may be big enough to make more foreign investors give India another look.
This is a classic healthy correction: the divergence between valuation and fundamentals is diminishing.
Of course, capital flows and relative valuations are not the only drivers of investment decisions.
Robust earnings and return on capital are more vital over the long term. And most Asian equity markets have seen average earnings estimates decline since the summer of 2024 — some for much longer.
So even though Asian equity valuations may be more in line with the long-term regional average, careful sector and market selection is still warranted.
It also remains to be seen whether the recent correction will prove durable.
The Chinese equity rally has fizzled over the past month, likely because investors believe more direct fiscal stimulus is needed to boost consumption in the country.
If Beijing responds with more stimulative firepower, the initial beneficiaries may be investors seeking to find value across the region. Reuters
Manishi Raychaudhuri is chief executive officer of Emmer Capital Partners Ltd.