Advertisement
Advertisement
Opinion
Macroscope
by Nicholas Spiro
Macroscope
by Nicholas Spiro
Sell Japan, buy China? Why Asia demands cherry-picking from investors
- Rather than hugging a broad index or betting on a certain country, investors must be discerning and focus on themes and trends in each country
Pinning a narrative to shifts and trends in financial markets is why investment analysts and commentators exist. Traders love a good story, especially one that persuasively explains why certain economic or political developments cause asset prices to move in a particular direction.
Yet even the most compelling narratives have their limitations and can easily unravel because of market shocks or unexpected movements in prices that are difficult to interpret.
In Asia, it is more difficult to construct an overarching narrative because of the sheer size and heterogeneity of the region. Differences in countries’ levels of economic development and financial market maturity have been amplified during the past several years by far-reaching geopolitical realignments.
Japan, the largest advanced economy and the most important ally of the United States in Asia, has a 37.7 per cent weighting in MSCI’s benchmark Asian equity index. China, the biggest developing economy, has a 19.3 per cent weighting while India – the second-largest emerging market, the fastest-growing one and a counterweight to China – accounts for 12.9 per cent of the index.
Last year, the dominant narrative in Asian equity markets was “ABC”, or “anywhere but China”, as demand for investment products that excluded China surged. According to HSBC, China accounted for just 12.5 per cent of foreign institutional investors’ purchases of Asian stocks in 2023. Japan comprised 37.1 per cent, while India accounted for 34.4 per cent.
However, sentiment began to shift earlier this year. In February, China made up 34 per cent of foreign investors’ purchases, compared with 20.6 per cent for Japan and just 2 per cent for India. Moreover, the MSCI China Index, which tracks Chinese stocks listed at home and abroad, rose 28 per cent between February 1 and May 20.
On the other hand, Japan’s main equity gauge, which on February 22 surpassed its record high reached during the country’s late 1980s asset bubble, fell sharply in April and has since moved sideways. Even India’s stock market, whose epic bull run has yet to peter out, has been more volatile in recent months. Foreign investors have been net sellers of Indian shares this year.
A confluence of factors is at work. In China, outright bearishness has turned to cautious optimism amid signs of economic stabilisation and more forceful stimulus measures. In Japan, the relentless fall in the yen is fuelling uncertainty about the strength of domestic demand and the normalisation of monetary policy.
The unexpected loss of the parliamentary majority held by the governing Bharatiya Janata Party in India’s general election earlier this month has shone a spotlight on the troublesome politics of economic reform, making it harder to justify buying shares in the world’s most expensive major equity market along with the US.
The biggest shift in sentiment has been in Japan. On Wednesday, the yen dropped to its weakest level versus the US dollar since 1986. While a weak currency is a boon to the country’s exporter-heavy stock market, it has pushed up living costs and amplified the impact of the persistent decline in real wages. As the Bank of Japan debates whether to raise interest rates further, the acute difficulties in calling time on a decade of ultra-loose policy are becoming more apparent.
Just as Japan’s equity market was a big beneficiary of the dramatic deterioration in sentiment towards China last year, a less pessimistic view of Asia’s largest economy could limit the amount of new foreign money flowing into Japanese stocks. According to HSBC, if China’s equity market remains relatively stable, “fresh flows into Japanese markets will stall”.
India could also lose some of its appeal. Domestic investors, in particular retail investors, keep pouring money into the stock market, turbocharging the rally. While valuations continue to rise, the percentage of companies upgrading their earnings estimates has fallen sharply in the past year, according to Societe Generale.
These shifts in sentiment show that the “Asia ex-China” investment strategy that proved popular last year was never as compelling as its proponents claimed. However, the outlook for Chinese stocks remains uncertain. The crisis in the housing market is dragging on, the economic data is mixed at best and the long-awaited recovery in corporate earnings has yet to materialise.
A more convincing narrative for the region’s biggest equity markets is Asian idiosyncrasies. Rather than hugging a broad index or betting on one country as opposed to another, investors need to take a more discerning approach that focuses on structural themes and trends in each country. Asia is a market for stock pickers, not passive investors.
While the yen will continue to be under pressure until such time as the gap between US and Japanese interest rates starts to narrow, the fact remains that inflation, wages and borrowing costs are all rising – a game-changing development after decades of deflation. This is driving corporate governance reforms. Banks and insurers, which benefit from rising rates and shareholder-friendly reforms, are outperforming the market.
In China, several sectors dominated by state-owned enterprises benefit from resilient earnings and offer high dividend yields, increasing their appeal in a low-rate environment.
In India, infrastructure stocks remain a safe bet as the focus on building motorways, railways and airports takes precedence. Bank of America sees “a long runway for [infrastructure] build-up, still in the third year of a multi-year [capital expenditure] upcycle”.
Narratives come and go, especially in a diverse region like Asia. The best investment strategy is one that cherry-picks the sectors enjoying the strongest tailwinds in each market.
Nicholas Spiro is a partner at Lauressa Advisory
Post