Chindia: sprint finish

China and India are diverging again. Since the beginning of March, the MSCI China index is up one-fifth; MSCI India is down nearly one-tenth.

This is not what one might have expected: macro data have favoured India, where growth in output has been revised up and, at 7.5 per cent, is set to surpass that of China this year.

Institutional investors have been unprepared for China's stock market rally. Asia fund managers are very overweight India, but only slightly ahead of benchmarks in China, on EPFR and MSCI data. Notably, as China's rally has advanced, China country funds have had net outflows in all but two weeks of this year. Citi says that there is less global money invested in China now than at the start of 2012. India has one-tenth more than then.

The liquidity environment is similar in both countries, with falling rates freeing cash to chase equities. Yet despite the rally in the MSCI China index, multiple expansion has not been excessive. This is partly down to the constituents: MSCI China includes stately Hong Kong-listed shares such as PetroChina, Bank of China, Lenovo and Haitong Securities, but not racy Shanghai and Shenzhen-listed A shares, which have simply exploded. Still, Citi notes that MSCI China earnings are 58 per cent above their 2008 peak. India's earnings, meanwhile, are only 6 per cent up from pre-crisis levels.

Volatility might also favour China: its volatility index has risen sharply this month, meaning investors must pay up for options to buy or sell shares in the future. Last week, the index hit 32, one-third of the high set at the peak of the 2008 panic. While also up, India's volatility index is only 19, below the average of 25 since 2008.

This suggests that investors are increasingly scared about the rally in China. The more fear there is, the more likely it is that institutions will delay investing - until they have to capitulate and play catch-up. China shares still have room to outrun India.

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