New era for Asia equities to be led by India and Japan as China stumbles, says Morgan Stanley

• India’s weightage on the MSCI All Country Asia Pacific Index (excluding Japan) has sharply risen by 4 percentage points to 10% in October 2023 from 6% in 2021.
• India has delivered strong relative earnings, sustaining the strong market outperformance seen in 2022, while macro-fundamentals have withstood a sharp tightening in US financial conditions.
• The reasons why the leadership in Asian equities is expected to change is due to shifts happening in a multi polar world.
  

India could well be on its way to becoming another China. India will potentially lead the new era of equities in Asia, says Morgan Stanley in its outlook for 2024. As China battles with debt deflation, sharp slowdown in growth and currency volatility, India continues to be the ‘Goldilocks Economy’ with nominal and real GDP growth far outpacing China’s in 2024.

As India continues to grow its corporate earnings and GDP growth at a steady clip, the country’s weightage on the MSCI All Country Asia Pacific Index (excluding Japan) has sharply risen by 4 percentage points to 10% in October 2023 from 6% in 2021, while China’s weightage has fallen from 26% in 2021 to 19% at present. What this means is that even if India does nothing, passive capital flows will continue into India as global investors follow global indices while allocating investments.

According to the global investment bank, India has seen the largest gain over this period, while Australia added 2 percentage points to 11% to remain the third largest market. Japan added 1 percentage point and stands at 33% of the regional index. Japan's investable market weight in the MSCI index was previously on track to be overtaken by China, but now stands at 73% larger than China's, as of 8 November 2023.

Morgan Stanley expects Indian equities to deliver 12% returns by December 2024 while it expects China to deliver only 4% growth during the same period. The US investment bank says that 2023 has been a pivotal year for the three largest Asian equity markets, building on the sharp reversal of the 2017-20 trends that started in January 2021. The structural shift is in terms of leadership changes. Emerging market trends will now be driven by India and Japan.

Morgan Stanley says: “Japan has convincingly emerged from three decades of economic stagnation (although it exited deflation in 2013, growth had been lacking), while seeing an acceleration in corporate reform. India has delivered strong relative earnings, sustaining the strong market outperformance seen in 2022, while macro-fundamentals have withstood a sharp tightening in US financial conditions.” In contrast, China has seen a lacklustre recovery post pandemic amid structural headwinds from the '3D Journey' of debt, demographics and deflation, while Multipolar World-related derisking has further weighed on valuations.

The reasons why the leadership in Asian equities is expected to change is due to shifts happening in a multi polar world. The ongoing developments in the multipolar world are significantly influencing global investment and technology flows, creating a potential war of attrition in rapidly growing sectors such as electric vehicles (EVs), cleantech, and artificial intelligence (AI) applications, including edge-AI empowered hardware, explains MS in its report.

One noteworthy recent development is the expanded impact of US semiconductor export controls, which were initially introduced on 7 October 2022. Simultaneously, European policymakers have launched an investigation into Chinese EVs, potentially leading to further trade restrictions.

Supply chains in the clean technology sector will remain a focal point, considering the dominant presence of Chinese vendors. While this incumbency provides short-term economic leverage, recent licensing requirements for key resources like graphite and gallium highlight the potential risks associated with overreliance on a single source. As supply chain de-risking gains momentum, it may impact both capacity utilisation and profit margins in the long run.

India could be a beneficiary of these developments as it firmly positions itself as an alternative to China.