Compelling opportunities all around Asia ex-Japan

December 22, 2023 08:10
Photo: Reuters

Asia ex-Japan equities look set to finish a challenging year behind their developed market peers. However, the weak performance masks divergent returns across the region’s markets, reflecting the wide range of market drivers at play. There are compelling stock valuations and fundamentals in various parts of the investment universe, which supports a constructive view from the bottom up as we enter 2024.

Lower correlations across markets

We have long viewed Asia ex-Japan equities as a diverse asset class, and we believe the region’s markets have become even less correlated in the past few years.

China’s economic cycle has become increasingly more distinct from the rest of the world, and we have seen their valuations decoupled from their regional peers. In our view, valuations for the China-Hong Kong component are compelling, though their fundamentals are less so. This contrasts with the strong fundamentals but less appealing valuations that we see in the India-Southeast Asia category.

Markets in India and much of Southeast Asia have broadly benefited from a shift in foreign direct investment and portfolio flows away from China in recent years. It is worth mentioning that India and Indonesia have also fared well on the back of sound government policies and strong domestic growth engines.

We view three of the region’s most advanced markets, Taiwan, South Korea, and Singapore, as cyclicals with relatively greater exposure to the global economy. In particular, Taiwan and South Korea tend to be more closely linked to the technology hardware cycle, and given the differentiated factors influencing each market in the region, their performances understandably vary.

While the diversity of Asia ex-Japan markets should favor stock picking, finding winning stocks has been more difficult in recent times as macroeconomic events have overshadowed company fundamentals. Going forward, we expect fundamental factors to reassert themselves once more and an environment that is more conducive to bottom-up stock selection.

Judging from our bottom-up research, many companies have braced themselves for a tougher operating environment and are pursuing self-help in various ways, seeking new markets, vying for market share, or increasing share buybacks, for example.

China: cheap valuations and more

The first key area of investment opportunity we see in China are the pockets in the market where valuations look heavily depressed and fundamental conditions are stabilizing. Internet companies, for example, endured years of intense government scrutiny, but with that now easing, businesses are able to refocus on growth. In real estate, policies to curb leverage and home prices have eased marginally as officials shore up the economy, sending encouraging signals for some property stocks.
The second is in companies along the electric vehicle and green energy supply chains, which are well positioned for multiyear expansion, not just domestically, but also abroad as they ramp up exports. Related to the second tailwind is our third area of opportunity—import substitution in China. Geopolitical tensions have forced China to rely less on imports and to become more self-sufficient via accelerated innovation, especially when it comes to making semiconductors, software, autos, and a host of industrial products. We think Chinese manufacturers that are successful in building capabilities to take market share from foreign competition within China may enable them to gain market share outside of China as well.

Structural reforms buoy India

India is reaping the rewards of its structural reforms from the past few years, including measures to lift tax revenues as a percentage of gross domestic product (GDP), thereby improve the country’s fiscal position. The country’s “Make in India” initiative to become a global manufacturing hub, coupled with geopolitical friction that has prompted supply chain shifts, has also supported its economy.

The resilience of India’s economy has come through in the latest period of rising US interest rates, and Indian companies have weathered this period well, delivering good earnings growth. Nonetheless, some stock valuations in India appear hard to justify, with multiples in certain areas rerating significantly ahead of projected earnings growth. In particular, stock multiples have climbed partly due to a surge in domestic investor inflows, especially in the mid-cap space. A reversal of these flows may hurt the stock market, in our view.

The promise in parts of Southeast Asia

US-China tensions have strengthened the case for companies globally, including Chinese businesses, to diversify the locations of their supply chains in favor of Vietnam, and we expect sizable positive spillover effects for the economy as it continues to develop from a low base. Vietnam’s equity valuations have also moderated amid the government’s anticorruption campaign and a property market slowdown.
Indonesia’s bid to diversify its economy away from commodity exports has led to increased infrastructure spending, a greater focus on investments in higher-value downstream industries, and a digitalization push. While it continues to enjoy gains from higher commodity prices in recent years, we expect its economy to become less exposed to the commodity cycle and more resilient over time.

The Philippines is unique for the large remittances it receives from a vast number of Filipinos working overseas. The inflows have traditionally supported domestic consumption, acting as a crucial source of stability for the economy when activity slows. Although the property market has been weak, we see indications of an improvement in 2024, which would bode well for the earnings of several major Philippine companies with real estate exposure.

What lies ahead

We see plenty of investment opportunities on offer for Asia ex-Japan equities. The return drivers are diverse, which has become more apparent given our view of reduced correlations between the region’s markets, but navigating risks still matters. Regulatory priorities in China and Vietnam, India’s general election next year, and US-China relations are still some areas to watch, yet we think bottom-up investors with a prudent eye on risks are well positioned for the year ahead.

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Portfolio Manager, Asia ex-Japan Equity Strategy, T. Rowe Price