CNBC's Inside India newsletter: Is India's equity losses due to China's stock market rally?

This report is from the CNBC "Inside India" newsletter, which provides timely and insightful news and market commentary on the emerging powerhouse and the big businesses driving its rapid growth. If you find it interesting, you can subscribe here.

The big story

Investment returns have been the sole focus of the investment world in recent weeks.

Beijing's aggressive monetary stimulus package and support for its struggling property market have made China the preferred investment destination for market participants.

Since the stimulus measures were announced, China's stock market has experienced a 25% increase, while India's stock market has seen a 3.5% decline. Over the past 10 trading days, Indian equities have lost ground on seven days, while Chinese stocks have risen on all but one day, according to CNBC's count.

The correlation between the two equity markets over the past two weeks raises the possibility that the strong returns in India may have contributed to the decline in Chinese asset prices over the past four years. Additionally, there is a concern about whether this trend may reverse in the near future.

Citi strategists have noted that there is some evidence linking China's gains to India's losses in the short term. They observe that when there were significant outflows from China, there was a similar pick-up in inflows to India.

Chris Ma, head of Asia quantitative research at Citi, stated that while fund flows are interchangeable and it is challenging to determine the direction of flows, it is possible that investors may start taking profits from overweight India positions to fund underweight China positions.

Rupal Agarwal of Berstein downgraded India to "Underweight" while keeping the bank's "Overweight" stance on China. She explained that India's market is vulnerable in the near-term due to record high relative valuations compared to China and emerging markets, which are already showing signs of a peak.

If more rumored stimulus measures are confirmed, there could be further pain for Indian equity investors. The impact would depend on whether the measures announced will primarily target China's stock market or the real economy.

David Aserkoff, JPMorgan's equity strategist, warned his investors that the stock market rally may falter if the underlying economic conditions remain difficult.

If the new/improved swap facilities only increase Chinese stock purchases and the economic stimulus does not boost Chinese economic growth, then there is no upside for CEEMEA stock markets, according to Aserkoff, who made this statement the day after the stimulus measures were announced.

Morgan Stanley's strategists predict that the MSCI China index will remain "range-bound" in the second half unless additional policy measures are announced.

Despite the potential improvement of China's economy and stock market, experts predict that it will not negatively impact the Indian equity market's growth prospects in the long run.

According to Wall Street observers, a robust and expanding economy, along with a robust domestic investor base, continue to be significant drivers of the Indian stock market.

"According to Jonathan Garner of Morgan Stanley, the Indian market has several positive domestic drivers that support our overweight recommendation. These include strong real and nominal GDP growth, high earnings growth, and the best demographic underpinning for equities demand in our coverage."

Citi strategists concurred with the view and stated, "We would purchase any dips."

— CNBC's Michael Bloom contributed reporting.

Need to know

Tata Sons Chairman N Chandrasekaran confirmed the death of Ratan Tata at age 86. Tributes for Tata have poured in from various leaders, including India Prime Minister Narendra Modi, Mukesh Ambani, and Sundar Pichai. Tata Sons, the parent company of the Tata Group, operates nearly 100 companies across various industries, including commercial aviation, steel production, and automobile manufacturing. Tata, who retired as chairman of the group in 2012, led over 60 global acquisitions. The cause of death was not revealed.

Ola Electric has been issued a "show cause notice" by the Central Consumer Protection Agency of India after receiving over 10,000 complaints. The issues raised include poor after-sales service and unclear invoices. Since their listing, Ola Electric's shares have fallen by approximately 40%.

India's foreign exchange reserves increased by $12.6 billion during the week ending September 27, bringing its total reserves to $705 billion. This makes India the fourth country to reach this milestone, following China, Japan, and Switzerland. According to BofA Securities, the Reserve Bank of India (RBI) appears to be relaxed about holding larger forex reserves due to its desire to build up buffers against potential external risks.

India's growth aspirations cannot solely depend on economic expansion, as the country must also prioritize environmentally sustainable development, which will require $1 trillion over the next decade. Despite this, private sector capital expenditure has not increased as much as desired, with India accounting for only 1% of the global green bond market.

What happened in the markets?

Despite a 4.5% loss last week, Indian stocks have shown improvement this week with the Nifty 50 index closing at 24,900 points, up 15% year-to-date.

The Indian government bond yield has decreased to 6.76% after increasing by over 20 basis points in the previous week.

This week on Biz Focus Hub, Young Liu, chairman of Hon Hai Technology Group (Foxconn), stated that Foxconn's production in India has the potential to significantly increase in the coming years. Although India's supply chain is still being developed, Liu believes that "they will eventually have their own supply chain," similar to China. The current administration is very supportive of businesses and industries, added Liu.

James Thom, senior investment director at Abrdn, stated that the Indian market is a fundamental story, while the Chinese market is driven by sentiment. According to Thom, the Indian market has seen robust economic growth that is filtering through earnings growth. Although the valuations of Indian stocks are high, Thom believes there won't be a material de-rating because the trajectory, fundamentally, is very sound.

What's happening next week?

Investors will focus on inflation reports for the U.S., U.K., and India next week, while Garuda Construction and Engineering will go public on Tuesday.

The U.S. producer price index for September, the U.K.'s GDP, and JPMorgan Chase and Wells Fargo's earnings are all important economic indicators.

October 14: India consumer price index for September

The IPO of Garuda Construction and Engineering, earnings reports for Bank of America, Goldman Sachs, and Citigroup on October 15.

October 16: U.K. consumer price index, earnings for Morgan Stanley