Allure of diversification via Asia-Pacific exposure
MARKET uncertainty has resurged, propelled by sticky US inflation, the path of Federal Reserve rate cuts, and heightened geopolitical risks.
The key question now is whether the Fed will proceed with its anticipated rate cuts, given persistent inflation challenges. While the current US monetary policy is restrictive, hence allowing for future rate cuts, the timing remains uncertain.
The current US monetary policy, while restrictive, leaves room for potential easing, especially as inflation approaches the Fed’s 2 per cent target, making the current yield levels on safe-haven bonds and investment grade securities particularly compelling.
Do not bet against the US
The big question is whether the recent pullback in equity markets is a blip or a precursor to a much-bigger correction. But despite these fluctuations, there are indications of a broader cyclical story, with improvements in the US manufacturing sector, and better global manufacturing Purchasing Managers Indexes (PMIs).
This positive momentum has been reflected in the broadening of cyclical asset performance and in our view, has led global macro conditions to be more constructive.
This also suggests that US equity markets could see further growth.
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Moreover, diversifying across sectors to include the industrial and consumer goods sector with an improving earnings growth outlook could offer additional opportunities for investors.
Opportunities in Asia
Asia remains an important driver of global growth, providing plenty of investment and diversification opportunities for investors globally.
The key to investing is diversification, which is only achieved through finding uncorrelated returns. The pace of change in Asia is rapid, and investors must stay agile to navigate the dynamic markets.
While China presents long-term asset growth potential, it may be hard to foresee sustained upside for Chinese equities due to near-term challenges.
Japan on the ascent
Japan emerges as a compelling opportunity for diversification, boasting a well-diversified stock market and low correlations to other asset classes. With the third largest bond market and fourth largest equity market globally, Japan has the capacity to absorb substantial capital inflows.
Japanese monetary policy has diverged from that of other developed economies for decades, maintaining loose policies due to persistent disinflation. However, recent global inflationary pressures, particularly the post-pandemic reopening, have resulted in a shift in Japanese inflation dynamics.
Inflation is a game changer for Japan. It creates a virtuous cycle – wage hikes translate into more consumer spending, which will enable quality companies to increase prices and profit margins. Inflation may also induce Japanese households to reallocate their cash deposits into the equity market.
The sector composition of Japan’s stock market is well-diversified compared with other developed markets. For example, rather than being dominated by a handful of tech stocks, as in the US stock market, or by the semiconductors as in Korea and Taiwan, Japan provides access to a range of industries, along with low correlations to other asset classes. For global investors, all this translates into portfolio resilience.
Japan’s ongoing corporate reforms and technological advancements further bolster its appeal.
South Korea to ride on AI-driven demand
South Korea, with its significant semiconductor industry exposure and strong ties to Asian growth, provides another avenue for diversification. As the semiconductor industry continues to flourish, South Korea – a major producer of memory chips – is poised to benefit from rising demand for artificial intelligence (AI) technologies and investments.
Korea is currently engaged in its most comprehensive corporate sector reform in decades to improve shareholder returns in the equity market.
Previous attempts at improving corporate governance have made progress in terms of reducing cross-shareholdings, raising dividends, and improving transparency. But there is room for improvement in capital management.
After Japan’s strong market performance, there is a hope for improvement Korea’s corporate reforms, which can be similarly rewarding.
Asean and India
The story of Asia over the past few decades has been mostly about China. However, Asean and India are emerging as new growth frontiers, fueled by young demographics and expanding middle-class consumers.
India presents similarities to China with its relatively closed economy, rapid growth trajectory, and increasing attractiveness to offshore investors. Foreign holdings in Indian assets remain modest compared to other markets, offering insulation from volatile capital flows. With a significant portion of exports of services, particularly IT, India is less vulnerable to global economic slowdowns. This further reduces correlations with global economic conditions.
India has been one of the standout markets in recent years with eight consecutive years of positive returns. The country is already one of the largest economies in the world and is one of the few places with strong demographic growth, raising its potential to become one of the fastest-growing countries in the world over the next decade.
When investors purchase Indian equities, they are really buying exposure to India’s large and growing domestic economy; almost 80 per cent of corporate revenue comes from domestic sales .
Asean offers one of the most exciting structural growth stories in Asia, thanks to a rising middle class. With a population of over 680 million, the region’s middle class will become one of the world’s largest economic locomotives in the next decade.
Asean is also a key beneficiary of the diversification of global supply chains. Furthermore, the implementation of the Regional Comprehensive Economic Partnership (RCEP) will further integrate trade and accelerate investments in the region.
The writer is chief investment officer (SEA and India), HSBC Global Private Banking & Wealth
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