Tipping the balance

A monthly guide to investing in Asia Pacific financial markets

As the first half of the year comes to an end, several of the world’s best-performing regional equity markets—Taiwan (+24%), Korea (+22%), Japan (+15%) in USD— and its two fastest-growing major economies—China and India—can be found in Asia. This puts a spotlight on the relatively stronger growth, policy, and earnings picture we see for the region compared to developed markets. Yet, overall returns (MSCI Asia ex-Japan +6%) have lagged the global equity rally by more than 7 percentage points year-to-date.

Looking into the second half, we expect this regional underperformance to reverse as new and existing tailwinds tip the balance further in Asia’s favor. Drilling deeper into these trends also reveals differentiated opportunities for investors in both China and across the rest of the region.

Japan awakens

To start, structural changes in Japan have pushed investor interest to generational highs and the TOPIX to a 33-year peak. As deflation ends decisively, nominal growth could accelerate to 2% p.a. in the years to come from 0.4% p.a. from 1993–2019. Real growth could also outpace both the US and Europe through 2024.

Over the medium term, Japanese equities could rerate to P/E levels last seen during the Abenomics era if reflation sticks and corporate governance reforms are executed. But these drivers will take time to develop, and we see risk for profit-taking after the strong year-to-date rally. This means a more selective approach to the market is warranted—we prefer big-cap banks, domestic reopening beneficiaries, and corporate restructuring candidates.

We also keep a most preferred view on the yen, given that 3Q could see the Bank of Japan adjusting its yield curve control policy as wage inflation proves more sustainable.

Consumption boom in EM Asia

Meanwhile, we think lower inflation and 2H rate cuts will reinvigorate consumption across emerging Asia. India is a particular standout backed by improving cyclical and structural prospects, and we turn most preferred on the market this month.

Service consumption is also set to broaden in Southeast Asia. After underperforming through 2022 and the first half, we think select segments of ASEAN’s new economy such as ride-hailing will now play catch up given falling competition, lower cost of capital, and as the year-long focus on profitability bears fruit. “Banks for the next billions” in India, Indonesia, and the Philippines are also set to see more than double the earnings growth of broader Asian banks.

In North Asia, major chipmakers have profited from a bottoming semi cycle and, to a lesser extent, optimism over future AI-driven demand. But while we still see plenty of long-term growth potential in the space, higher valuations point to limited upside in semiconductors versus broader Asian equities from here—we lock in performance and downgrade Korea to neutral. However, investors looking for AI exposure can still find less expensive opportunities further down the value chain in mainland China, Korea, and Taiwan, where revenue expectations are not yet as high.

Staying in China

China remains the economic powerhouse of the region. We expect the economy to contribute just under half of all global growth this year as targeted policy steps are taken to safeguard the recovery. The Politburo meeting at the end of July is key to more policy clarity, but investors should temper expectations for large-scale stimulus. The government appears determined to prevent a further build-up of systemic financial risks as it focuses on rebalancing its economy and longer-term industrial upgrades.

Geopolitical tensions are also unlikely to meaningfully improve, even if we think they should stabilize with the resumption of dialogue between officials, and private sector confidence is negative at the moment. From a market perspective, however, valuations are approaching cycle lows, positioning is light, and earnings are improving. We think these are compelling reasons to remain constructive on Chinese and broader EM equities—both are laggards that could stage a double-digit turnaround by year-end, particularly if a softer landing materializes in the US. Thematically, we believe quality SOEs will benefit from structural reforms and an improved dividend outlook and expect competitively positioned internet platforms to join in on the macro recovery. The yuan—now highly inexpensive on a real effective exchange rate basis—should partially reverse its slump against the dollar in 2H.

Add diverse and durable income

Elsewhere, we think the high-yielding IDR and INR will perform well as US interest rates peak and the USD comes under pressure. Asia IG bonds and regional dividend stocks, which are yielding an attractive 6.4% (vs. historical average of 4.7%), should also benefit from the approaching end of the Fed’s hiking cycle and are among our most preferred defensive positions.

As is the case around the world, investors in Asia will need to perform a balancing act between seeking higher returns and navigating global risks. But we see numerous unique opportunities in the region for the months ahead.

Written with Mark Haefele, our Chief Investment Officer.

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