Asia Mid-year Outlook 2024: Rising optimism but risks on the horizon

What we think

The outlook in Asia remains relatively stable even as economies have grappled with a ‘higher for longer’ environment and some stubborn inflation pressures. However, markets are seeing support from a global cyclical uplift and central banks have been careful in balancing growth with stability. Furthermore, Asian economies can gain market share from accelerated trade redirection as a result of increased trade tensions and benefit from the ongoing boom in artificial intelligence.

Investment implications

We retain a broadly constructive view on Asian markets. We continue to favor 1) Japanese equities on reflation and continued corporate reform, specifically in the financials, technology, industrials and real estate sectors; 2) Semiconductor leaders as key Artificial Intelligence beneficiaries; and 3) Indian equities as a long-term allocation following the conclusion of the general elections.

Overview

As we discussed in our Asia outlook report in January, most of Asia (with the notable exception of China) delivered strong equity returns despite a tough macro environment in 2023. That has continued into 2024 with a rally in China and the continued outperformance of Taiwan and Japan. In this note, we update our outlook for the broad Asia region, and will focus on China in an upcoming publication.

The global AI boom is also positive for many parts of Asia, including leading semiconductor players in Japan, South Korea, and Taiwan. Asia’s trade cycle has historically been correlated to the global investment cycle, particularly that of the U.S. Considering 30% of Asia’s goods exports are in tech, the U.S. tech investment cycle has implications for the region’s exports and India’s IT services exports. This could continue to provide a tailwind for Asia, as we expect the AI buildout and tech capex spending to remain strong in the U.S.

Investment ideas for Asia

Against this backdrop, we continue to hold a broadly constructive view on Asia, while focusing on the following investment themes:

• Japanese equities on reflation and continued corporate reform, specifically in the financials, technology, industrials and real estate sectors.
• South Korean and Taiwan semiconductor leaders as key AI beneficiaries.
• Indian equities as a long-term allocation following the conclusion of the general elections.

Japan macro: To hike or not to hike

Earlier this year, we wrote about reflation as a macro regime shift for Japan, and the investment opportunities presented to investors over a multi-year horizon. To recap, we see multiple tailwinds supporting Japan’s transition from deflation to reflation:

1. A virtuous cycle of rising wages, stronger consumption, and higher nominal growth.
2. A shift in global supply chains and technological trends.
3. Export competitiveness due to a weak JPY.
4. Fiscal incentives aimed at attracting global investments.

All of these factors are still in place, and in our view will likely continue to support the performance of the Japanese economy and market in the rest of 2024 into 2025.

Cyclically, Japan’s economy can benefit from a recovery in global trade and further normalization of domestic demand. Japan’s May 2024 manufacturing PMI rose into expansion for the first time in 12 months. An upturn in global trade usually bodes well for Japan’s export-oriented economy. Furthermore, in the current global environment, Japan is also uniquely positioned to benefit more meaningfully for two reasons.

First, Japan has a significant comparative advantage – or virtually monopolistic positions – in some parts of the semiconductor supply chain. This puts Japan in the center of two secular growth trends: the global race for semiconductor resiliency and the development of AI.

Given the growth and inflation trajectory, we think the BoJ will likely not hike rates in 2024. The BoJ’s own forecast is for the economy to reach “sustainable 2% inflation” in late 2025. Greater confidence in this outcome could allow for a modest rate hike (around 20bps) in 2025, but there appears no need to rush.

In recent weeks, persistent JPY weakness has led some analysts to argue that the BoJ needs to raise rates more quickly and aggressively to prevent runaway imported inflation. We disagree for three reasons:

1. We doubt Japan’s interest rate policy can be used successfully to influence the exchange rate.
2. Imported food and energy prices are temporary factors, and more so in Japan than in economies like the U.S.
3. There is no evidence that the JPY exchange rate adds to meaningful inflation.

While markets could remain vigilant over oil prices and FX developments, vigilance is insufficient justification for tightening. 

After three lost decades, policymakers in Japan have welcomed reflation with open arms. Our base case is that the monetary, fiscal and regulatory environment will likely remain highly conducive to continued reflation and economic normalization in the coming quarters.

Japanese equities: building on reflation

We remain positive on Japanese equities, with a focus on financials, technology, industrials and real estate. We initiate a June 2025 TOPIX outlook of 3,025-3,125, offering low-mid teens percentage point total return over the next 12 months. Corporate earnings growth in the March quarter remains above developed market peers at 10% YoY, and we expect 9-11% earnings growth over the next 12 months. In addition, corporate reform is accelerating, with share buybacks growing 50% YoY. While corporate guidance for FY25 earnings to decline 1-2% YoY appears somewhat conservative, we believe this leaves scope for guidance to be revised higher over the next six months. Companies are increasingly of the view that price increases are becoming persistent and domestic capex spend is back at an all-time high, implying further evidence that reflation is back.

• Financials: With reflation returning, we expect nominal GDP growth to re-accelerate relative to the past two decades. Financials, and particularly banks, are among the most sensitive sectors to an improvement in nominal growth.
• Technology: Japan is one of the global leaders at manufacturing specialized semiconductor capital equipment, components and tools for the industry. In some cases, Japanese producers have a near monopoly in specific elements of the semiconductor supply chain. With increased capex driven by shifts in global semiconductor supply chains (which benefits Japan), rapidly expanding investments in artificial intelligence advancements, and a nascent cyclical recovery, the sector remains well-positioned for above-market earnings growth in the years to come. 
• Industrials: After an 18-month downcycle in global manufacturing, we are finally seeing signs of recovery via U.S. ISM and global manufacturing PMIs. Historically, Japanese industrial companies that specialize in manufacturing capital equipment, robotics, and machinery see an uptick in new orders that results in accelerating sales and expanding margins when global manufacturing PMIs rise.
  
• Real Estate: Reflation is driving property prices higher in Japan, particularly in the main economic growth engines like Tokyo. Owners of prime real estate stand to benefit from asset revaluation, property sales, and increased rents.

JPY: carry is the name of the game

The JPY has weakened substantially both against the dollar and on a trade-weighted basis. As the only G10 currency with near-zero interest rates, the JPY has been widely used as a funding currency and dominated by moves in global yields. As shown in the chart below, USDJPY has closely followed U.S. yields since the Fed embarked on the tightening cycle. 

We expect the JPY to stay on the weak side until U.S. rates decline substantially. The JPY’s negative carry against the USD (>5%) is so substantially wide that even if U.S. rates stay range-bound, the JPY could continue to weaken over time. Recent direct FX interventions are an attempt to stem sharp volatility in the currency. However, unilateral FX interventions are often unsustainable and unlikely to reverse the trend over the longer term. A potential risk scenario of a persistently weaker currency and higher energy prices may cause the BoJ to raise rates faster.

These cross currents and uncertainties are why we are generally neutral on JPY from a trading perspective. We continue to favor borrowing JPY to invest into Japanese equities or doing so on an FX-hedged basis.

South Korea and Taiwan: AI beneficiaries

We remain positive on South Korean and Taiwanese equities and continue to see tactical opportunities. These markets stand to disproportionately benefit from the strong semiconductor cycle centered around AI. Corporate development of AI capabilities could drive significant multi-year growth through rising capex, and we see the global semiconductor space potentially growing to US$1 trillion by 2030. Cyclical semiconductor demand could also see a recovery as inventory levels have normalized.

In Korea, capex and production cutbacks in the DRAM (Dynamic Random Access Memory) industry have started to bear fruit. Contract prices for DRAM have been rising, with further increases likely as end-markets start to recover. HBM (High Bandwidth Memory) has become a critical component for enabling AI capability, providing fast-growing structural opportunities. We expect solid industry trends and emerging corporate governance reforms to drive an earnings upgrade cycle over the next 12 months, with meaningful valuation re-rating potential in Korean equities.

In Taiwan, the semiconductor industry has continued to benefit from a cyclical demand upturn and new growth drivers due to AI and high-performance computing. This will likely benefit leading edge foundry services. Earnings growth is expected to accelerate through 2024, supported by a number of key product releases.

India: first past the post

As of the time of writing, Prime Minister Modi’s Bharatiya Janata Party (BJP) has returned to power for a historic third consecutive term. However, the BJP has failed to cross the simple majority on its own, having to rely on coalition partners. The win was narrower than initial exit polls suggested, which has led to large market swings. This is the first time in the last ten years that the BJP will be running a government without an outright majority in the Lower House. A reduced political mandate and the challenge of managing coalition partners will likely make some reforms more difficult. However, the overall positive macro path is unlikely to be derailed. While we expect the business-friendly environment to continue, there could likely be some re-direction of fiscal funds towards welfare to help low-end consumers and rural areas.

Indian equities: strategic and structural

We have consistently reiterated that Indian equities provide unique exposure to an exciting structural high-growth opportunity that translates into sustainable low-teens earnings growth over the next few years. We believe the higher valuation for Indian equities is justified by the relative visibility and quality of earnings growth over the next several years. Near-term, we have also revised our earnings estimates 3-4% higher due to a strong finish to the fiscal year. Whilst more populist spending could feature in the new budget, the investment-led focus and business-friendly environment is expected to be maintained. We initiate a June 2025 outlook of 2,800-2,950 and reiterate our view of a strategic long-term ‘overweight’ towards India, and would be buyers of dips in the market. 

MSCI India is up ~33% over the last 12 months and is amongst the world’s best performing markets. Bouts of volatility such as the 3-5% pullbacks in both March and May offered opportunities to add or initiate exposure. Foreign ownership of Indian equities also remains low relative to history. Flows have been sharply negative since April with about US$4bn of outflows, so some money has already been taken off the table. We see this post-election pullback as an attractive entry point. Investors have to keep in mind that India has been one of the most consistent markets in terms of high corporate earnings growth, and the overall growth outlook is largely unchanged as a result of this election. 

Current volatility is presenting an opportunity as investors re-focus on attractive domestic fundamentals. Historically, the Indian equity market has returned high single-digits 3-6 months after elections.

Trade tensions pose risks

Just as exports are improving and the regional outlook is looking up, investors need to keep a close eye on rising trade tensions. Though much of the recent focus has been on China’s excess capacity and rapid increase in higher value added exports, there are two potential risks that could impact the broader region. The first is whether the U.S. looks to broaden measures to prevent trade re-routing. Part of the reason why ASEAN trade to the U.S. has increased is the re-routing of Chinese-produced goods through the region. There are also reports that trade provisions could look more closely at preventing China from using other countries where the U.S. has free trade agreements as a base of production, to get around tariffs. Lastly, trade looks to feature heavily in the upcoming U.S. elections, with President Biden already increasing tariffs and former President Trump threatening a substantial rise in tariffs as part of his policy platform. With trade so integral to Asia – any broadening out or substantial increase in protectionism is a risk to the region.

All market and economic data as of June 06, 2024 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.

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Index definitions

The Purchasing Managers' Index (PMI) is an indicator of the prevailing direction of economic trends in the manufacturing and service sectors.

The Consumer Price Index (CPI) is a measure of the average change overtime in the prices paid by urban consumers for a market basket of consumer goods and services.

The Tokyo Stock Price Index (TOPIX) is an important stock market index for the Tokyo Stock Exchange in Japan, which tracks the entire market of domestic companies and covers most stocks in the Prime Market and some stocks in the Standard Market.

The U.S. ISM manufacturing index, also known as the purchasing managers' index (PMI), is a monthly indicator of U.S. economic activity based on a survey of purchasing managers at more than 300 manufacturing firms.

The MSCI India Index is designed to measure the performance of the large and mid cap segments of the Indian market. With 136 constituents, the index covers approximately 85% of the Indian equity universe.

The NIFTY 50 is a benchmark Indian stock market index that represents the weighted average of 50 of the largest Indian companies listed on the National Stock Exchange. Nifty 50 is owned and managed by NSE Indices, which is a wholly owned subsidiary of the NSE Strategic Investment Corporation Limited.