2023 Asia ex Japan Equities Midyear Outlook: Focusing on Quality Stocks as Uncertainty Lingers

• A robust Asian growth story supported by gradually improving consumption spending should promote opportunities for equity investors in the second half of 2023, especially exposure to quality companies.

• Although China’s recovery looks increasingly rocky amid slowing demand and rising geopolitical tensions, we see pockets of mispriced opportunities at attractive valuations, including across services and tourism.

• India’s strong economic outlook is reflected in robust quarterly results and substantial foreign investor inflows, especially in financials. Core industries like cement, coal, electricity, and steel are also growing, with equity allocations from both domestic and foreign investors expected to fuel local markets.

A resurgence in appetite for Asian equities early in 2023 was a direct result of key drivers such as China’s inflation and growth paths for the first quarter, along with generally cheaper valuations across the region. Yet while economic prospects continue to look promising, investors should be vigilant – and therefore selective.

Various headwinds are top-of-mind for market participants, infusing uncertainty into outlooks and allocations. Among them are the general economic slowdown globally, along with US regional banking woes and concerns that the Federal Reserve will resume rate hikes – all of which are expected to promote continued market volatility. At the same time, heightened tensions between the US and China are keeping investors on edge.

In response, the Asia ex-Japan equity market saw a reversal of gains in the spring with China leading as the region’s worst-performing market, and Taiwan also suffering – in its case from a mix of geopolitical concerns and profit-taking in the tech sector.

On the other hand, during this period, Indonesia and India fared well. The former outperformed on perceptions of its defensive qualities given domestic household consumption and ongoing policy reforms. The latter saw the benefits of an improving banking sector and some gains in real estate.

While there has been a slight recovery, such divergence across markets and industries will likely represent the norm for Asian equities over the coming months. However, the region’s growth and inflation numbers from the first quarter point toward recovery, supported by gradually improving consumption spending.

Key Convictions

1. Select China equities will benefit as consumption improves.

After strong economic growth numbers beat market expectations in the first quarter of 2023, China’s rebound has since looked more uneven across sectors. In particular, consumption spending has yet to pick up to normal levels, while trade data indicate a long road to recovery. Coupled with slowing global demand and rising geopolitical tensions, volatile times loom.

That said, we maintain a positive stance on China, with a view to using volatility to our advantage to source mispriced opportunities. Notably, we see pockets of interesting long-term opportunities available at attractive valuations. Across services and travel-related sectors, for example, we expect certain high-conviction names to withstand the external disruptions and gain strength as domestic conditions improve following the expected boost to consumption.

More broadly, we are positive on the outlook for the China A-shares market based on the Politburo’s April meeting, which signalled a consistent and accommodative policy stance. In the hunt for alpha, fundamentals were back on investors' radar during the earnings season and will likely remain so.

Market sentiment for Greater China, meanwhile, is at the mercy of geopolitics. Evidence of waning economic recovery is weighing on investors, as is the delay in a restoration of business confidence, especially within private sectors.

As a result, policy will likely stay accommodative, suggesting a range-bound market for the time being. Inevitably, however, bottom-up stock-picking opportunities still exist.

2. India is reliably resilient.

Reflecting its status as one of the fastest-growing economies globally, India has seen its markets rise recently.

Good quarterly results and substantial foreign investor inflows are to thank, especially in the financial sector, due to high credit growth, strong balance sheets, and optimistic commentary. With financials comprising a significant part of the domestic index, sentiment is positive.

Beyond the banks, the volume indices for core industries like cement, coal, electricity, and steel show a robust upward trajectory.

The fact that India’s inflation is now under 5%, and bond yields are trending down, should eventually lower the cost of debt for corporates and for consumers. In addition, domestic investors continue to allocate significant amounts to the equity markets – with the AUM of the domestic mutual fund industry growing fivefold in a span of 10 years – while foreign investors’ allocations to India seem to be rising.

Particularly appealing is the potential for India as a technology and innovation hub, which aligns with the growth in the country’s digital economy, supported by investment in digital infrastructure and further reinforced by the government’s Digital India program.

3. Stick with what works: quality companies with long-term strengths.

In an environment of high rates and an uneven recovery in China, investing in equities has been challenging for many investors. In this environment we remain focused on stock selection, and the low valuation of China equities, earnings resilience of India companies, and economic recovery in ASEAN present interesting opportunities for long-term investment.

Specifically in Asia, as growth and consumption trends gather some momentum in the second half of the year, we think investors will be rewarded by pinpointing quality companies.

This inevitably requires a well-researched, bottom-up selection process, targeting those businesses with robust financials and competitive advantages. These are the names we believe should be well-positioned to weather any challenges, with strong fundamentals and efficient leadership underpinning return potential.

For more of our views on what investors and markets can expect in the second half, see our 2023 Midyear Investment Outlook.