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With Indian stocks surging and Chinese stocks disappointing, going long on India and short on China has become the latest emerging markets (EM) equity investing theme. American investment management firm Acadian Asset Management calls it “Rising Tiger, Falling Dragon” and cautions that investment trends like this are often superficially based and vulnerable to sudden sentiment reversals.
“At a superficial level, the thesis makes sense because the underlying sentiment that it captures is consistent with the macro picture,” commented Christopher Covington, Portfolio Manager at Acadian. “But divergent macro trajectories do not necessarily imply a promising investment opportunity.”
Covington points out that economic optimism about India and pessimism about China are reflected in market valuations. While Indian stocks are trading at a significant premium, Chinese stocks are trading at near-historic valuation discounts.
The portfolio manager advises investors to be cautious and consider “whether the market is now under- or overvaluing the broad economic outlook and whether they can time the further evolution of sentiment.”
According to Acadian Asset Management, investors may overlook short-term opportunities in stock selection if they only focus on macroeconomic themes. The “Rising Tiger, Falling Dragon” theme is a prime example. Investors who embraced this theme without analysing the fundamental differences within each market were missing out on significant opportunities, according to Covington, as fundamentally sound indicators such as value and quality were profitable in both India and China.
To underline his stance, Covington gives the example of India. “Thematic investors that allocated via country baskets have earned strong returns since 2021, roughly 60% (USD). Yet they could have done even better by tilting towards cheaper, higher-quality stocks”, he said. This is because the cap-weighted country basket favoured high-quality but expensive stocks, which underperformed.
While going long on India and short on China might still be worth pursuing, the asset manager suggests that EM investors could also look at the full cross-section of EM stocks. “The point is that macro-driven opportunities associated with ‘Rising Tiger, Falling Dragon’ may be available elsewhere in the full EM country cross-section. And in casting a wide net for such opportunities, we would also advise investors to carefully factor in valuations and sentiment, not just economic or fundamental growth,” Covington concluded.
