2024 Asia Outlook – A Year of Transition

Author: Asia Investment Strategy Team

 

Asian economies faced numerous challenges in 2023 – ranging from aggressive U.S. rate hikes to disappointing growth in China. Against a tough economic backdrop and lingering geopolitical risks, financial market performances were mixed amidst subdued capital flows. Local currencies generally weakened versus the dollar, even as many regional central banks shadowed the Fed’s hawkish stance. That said, the region still had some star performers in 2023. Equity markets in South Korea, Taiwan, India, and Japan saw strong double digit gains, supported by secular tailwinds and favorable fund flows.

We expect 2024 to be a transitional year, with hopes of stability paving the way for a more sustained recovery in 2025. As growth in the developed world, particularly the U.S., is likely to slow into a soft landing, regional export growth could stay challenged in the near-term. A broad-based export recovery may have to wait until global growth can re-accelerate, possibly in late 2024 or 2025.

Another potential turning point may come when the Fed starts to ease monetary policy and cut interest rates. This will likely translate into easier financial conditions, and expectations for a potentially weaker USD may help lead capital flows back to emerging markets (EM). Once the Fed is on a durable cutting path, central banks in Asia will likely also have more leeway to ease policy slightly in order to give local growth a bit more support. India – and Southeast Asia to some degree – can benefit more in this scenario. 

In this environment, emerging Asian currencies may see some additional support as headwinds from elevated energy prices and weak global trade gradually wane. Global financial conditions will likely also ease from highly restrictive levels as major central banks begin moving into a synchronized easing cycle. That said, we may need to wait until the second half of 2024 to see more sustained strength against the dollar, in line with our base case that the Fed could deliver the first rate cut in June.

Within the region, we could see differentiated performance amidst the concurrent forces of trade sensitivity, central bank divergence and geopolitics. Indonesian (IDR) and Thai (THB) currencies will likely remain supported by boosts to their current accounts as a result of robust commodity exports and continued tourism recovery respectively. The Indian Rupee (INR) is also relatively well positioned given its high carry and domestic orientation, as the Indian economy continues to benefit from cyclical and structural tailwinds. Risks around the Singaporean dollar (SGD) appear balanced given that inflation has already peaked in the city-state – and the Monetary Authority of Singapore (MAS) is likely to follow the easing pace of global central banks. In contrast, the Chinese Yuan (CNH) and Taiwanese dollar (TWD) will likely remain as funding currencies on carry disadvantage and geopolitical overhang.

What about China’s impact?

China’s lackluster growth is a problem for the Asian powerhouse, but also for closely-linked economies, particularly Hong Kong. In 2024 China will likely try to manage a transition away from real estate and into other sectors. We will be publishing a report to discuss the near and long-term growth outlook in China, the policy choices available and the investment implications. In short, while this transition is challenging, there are some policy options that can help to stabilize growth.

Over the longer term, ongoing shifts in global trade flows that diversify out of China can continue to benefit the region’s economy through increased foreign direct investment (FDI) and gains in global export market share, particularly for some Southeast Asian economies like Vietnam and Indonesia.

Some of our top ideas in Asia

Across the region, we are constructive on the following opportunities:

• Consider tactical opportunities in semiconductors, expressed through South Korean and Taiwanese equities.
• Close structural underweights in Japan and access long-term corporate reform opportunities through active managers.
• Increase long-term allocation to Indian equities to benefit from structural tailwinds.
• Be selective on Chinese equities through specific sectors.

Is the cycle turning for South Korea and Taiwan?

There have been some signs of a nascent pickup in the semiconductor cycle, which bodes well for tactical opportunities in South Korea and Taiwan.

Capex and production cutbacks in the Dynamic Random Access Memory (DRAM) industry have begun to bear fruit, and we are seeing rising contract prices. We expect this to continue in 2024 as end-markets such as mobile phones, PCs and servers could potentially start to recover. In addition, there are fast-growing structural opportunities in high bandwidth memory that could disproportionately benefit Korean DRAM companies. We continue to see meaningful valuation re-rating potential for the equity market that would likely coincide with an earnings upgrade cycle over the next 12-months. South Korea could also be a beneficiary of elevated geopolitical tensions in the region.

For the Taiwan semiconductor universe, activity levels likely bottomed in 3Q23, and we are starting to see leading foundry companies guide slightly ahead of consensus. In addition to benefitting from a cyclical upturn in demand as inventory levels normalize, new secular growth drivers in the form of rapid advancements in Artificial Intelligence are leading to increased demand for high performance computing chips. This will likely benefit leading-edge foundry services in the region. Earnings growth is expected to inflect higher in 4Q23 due to new key product launches and this will likely extend through 2024.

Can Japan continue rising?

While inflation was a headache for policymakers across developed markets, Japan was possibly the only economy where inflation was welcomed. Ever since its property market bubble burst in the 1990s, Japan’s policymakers have kept an ultra-easy policy stance in attempts to stoke inflation. While inflation has indeed arrived in this cycle, Japan is still at an early stage of reflating its economy.

The bulk of initial inflation was imported, and as a result, real wage growth was negative in 2023. The subsequent squeeze on households dragged on the domestic demand recovery, which was only partially offset by fiscal support. It was also helped by the bright spot of a strong tourism recovery, where ex-China visitor numbers have recently reached record levels. 

Slower global growth – particularly in developed markets and China – is a headwind this year, particularly for Japan’s important manufacturing sector. But there are also signs of a more virtuous reflationary cycle developing. This is supported by three factors: 1) a structurally tightening labor market; 2) a deliberately dovish policy to sustain positive inflation expectations; and 3) a revival in private sector investment.

Despite slower global growth, Japan could hold on to some of its reflation progress. A key data point to watch is the annual spring wage negotiations. A four to five percent wage gain can tip real wage growth into positive territory this year – in turn helping to support household spending.

An improving corporate sector outlook and more pro-growth policies may also help sustain the recent boom in private sector investment. After decades of stagnant wages, the Bank of Japan (BOJ) will likely wait patiently to see clear signs of sustainable wage gains before making further policy adjustments. If more reflation progress is made, an exit from negative interest rates is a reasonable next step in 2H 2024. A rate hike is not impossible, but is not a base case in 2024 given that the risks of runaway inflation have already diminished. Overall, policy moves will likely be gradual, keeping real rates in firmly negative territory.

For the Japanese currency, interest rate differentials will be one of the key factors to watch. Changes in the rate gap between U.S. Treasuries and Japanese Government Bonds (JGBs) have driven 80% of the moves in USD-JPY over the past two years, and will likely remain the main factor underpinning the pair as we see more policy shifts from both the Fed and the BOJ in 2024. We think the yen could moderately strengthen this year to 133-137 on 1) increasing clarity that USD rates are past their peak; and 2) expectations of a gradual normalization of BOJ policies and higher JGB yields than current levels. Slow and subtle moves from the BOJ could imply only a gradual grind higher for JGB yields. 

2023 was one of the best years on record for Japanese equities, and the Nikkei 225 is tantalizingly close to its 1989 bubble era all-time high. However, recent weakness in global manufacturing PMIs has started to negatively impact Japanese corporate earnings. The weak yen has helped cushion the net impact. Japanese corporate earnings have historically been correlated to global manufacturing PMIs, and they have been diverging with the earnings revision trend. This bears close attention and underpins our relatively neutral stance on the broad index from a cyclical perspective. That said, there are emerging trends that imply we could start to see moderate inflation return, and potentially a greater focus on expanding domestic capex. We are positive on such emerging themes over the broader market.

A longer term theme that is increasingly capturing market interest is the progress of corporate reform in Japan. As a result of regulatory reforms and new Tokyo Stock Exchange (TSE) ‘name-and-shame’ initiatives for companies trading below book value, Japanese corporates are increasingly returning more cash to shareholders in the form of increased dividends and share buybacks.

The ultimate objective of the TSE is to encourage active dialogue between Japanese corporates and shareholders in order to improve corporate governance, returns on equity, and valuations. A starting point is for companies to acknowledge what their cost of capital is, and for share price performance to be considered. Other areas of current focus include increased English company disclosure, quality of corporate governance, and the effectiveness of communication with investors. Even for companies trading at high price-to-book ratios, the TSE is requesting that they promote constructive dialogue aimed at improving corporate value over the medium to long term. As companies meet the TSE’s current requests there is an increasing likelihood that the Exchange could initiate other measures to further raise the corporate governance bar in the near future.

We estimate that the addressable market of companies that have reasonable market caps, net cash and/or large cross shareholdings, and low valuations, to be 100 to 150. This provides plentiful opportunities for alpha generation through active managers. In addition, this could further create a virtuous cycle in terms of continuous improvement in corporate governance across the broader market and lead to a moderate re-rating of Japanese equities. While there are near-term macro uncertainties, this trend is creating a potential multi-year idiosyncratic reason for investors to consider Japanese equities, and has increased the probability of our bull case scenario for the TOPIX (2,770-2,840). Clients that are under-allocated Japan can consider closing the underweight.

A different take on India

Investors have turned to EM for the promise of stronger economic growth, and these economies have indeed expanded at a faster pace than their developed market counterparts. But there is a twist, which many investors do not fully appreciate: In most EM economies, corporate earnings have failed to keep pace with GDP growth. India is a striking exception. It is one of the few emerging markets where equity investors can benefit from underlying economic growth. Indian company profits, and thus stock returns, have tended to grow in line with nominal GDP. Data over the past 20 years show that India has one of the closest relationships between economic growth and market returns.

J.P. Morgan Asset Management’s LTCMAs project that India’s economy will likely deliver nominal growth of around 10% annually over the next 10 to 15 years. In our view, this makes India one of the most compelling investment destinations in EM.

India’s growth potential reflects an expanding middle class, digitization and especially favorable demographics. India’s labor supply will likely increase steadily until the 2030s, and because labor supply is strongly linked to output, this gives it a long runway to deliver sustained high rates of economic growth.

India’s prospects look especially appealing at a time when China’s long-term growth potential has declined, with far-reaching effects for the global economy and EM in particular. For example, China represents one of the largest sources of trade demand for Korea and Taiwan, due to its large appetite for semiconductors. It also ranks as one of the largest importers and consumers of many major commodities, directly impacting leading commodity exporters such as Brazil and South Africa. In many ways, EM economies are highly correlated with China’s economic cycle. Indeed, given the market capitalization of Chinese companies, the country effectively dominates the broad EM complex. For that reason, India’s lack of correlation appeals to many investors. The lack of correlation also applies to equity market performance.

Indian equities are not undervalued. Stocks trade at forward price-to-earnings (P/E) multiples that are higher than their historical averages. But the long-term outlook for India’s economy and equity markets appears better than it has in years, for several reasons:

• A likely sustained increase in foreign direct investment due to U.S.-China tensions and a redirection of supply chains benefiting India.
• Companies have steadily reduced debt levels over the past 10 years, leaving room for a new credit cycle to emerge.
• Structural reforms in the banking sector – a dominant component of the equity market –are designed to improve profitability and reduce risk.
• India’s business-friendly policies (including lower corporate tax rates) and preferential credit terms to set up manufacturing facilities in the country.

The Indian economy continues to be supported by better than expected economic growth, where real GDP grew 7.6% in 3Q23, and PMI’s that remain firmly in expansionary territory. This is translating into year-on-year earnings growth that is estimated to reach ~15% for the December quarter.

We now turn our focus on the two largest sectors: Financials and Information Technology. Banks continue to be supported by solid loan growth on the retail side, and while there is some net interest margin pressure, asset quality remains benign. Mid to high-teens earnings growth for financials seems achievable. One segment of the market that has been under pressure in 2023 was the IT sector, which  has been dragged lower from weak outsourcing demand from overseas clients. Recently we have started to see demand from clients in geographies such as the U.S. inflect higher, leading to higher than expected orders, and the first guidance upgrade in a number of quarters. Looking forward into 2024 and 2025, we are of the view that earnings can continue to compound at a low to mid-teens level, which underpins our positive view on the equity market in the year ahead.

One potential risk is the general election expected to take place in April or May. We view the recent state elections positively for Mr. Modi’s Bharatiya Janata Party (BJP). The BJP turned two states (Chhattisgarh and Rajasthan) from the main opposition, and kept another (Madhya Pradesh) with clear majorities. The results are much better than the exit polls suggested and bode well for continued economic reform, a pro-business environment, and stability in India.

A year of living dangerously

Finally, any assessment of 2024 would naturally involve the specter of geopolitics and its impact on the region’s economy and markets. Although oil prices have remained relatively contained on the back of strong supply, recent conflicts in the Middle East have led to spikes in shipping rates and concerns of a broader escalation engulfing the region, prompting fears that inflation may yet rear its ugly head again. While the ongoing Russian invasion of Ukraine simmers somewhat in the background, any escalation there could also impact broader commodity prices, in turn re-introducing inflation risks for importers such as India and Japan.

At the national level, more than half the world’s population (including Taiwan, Indonesia, India and South Korea within Asia) will be voting in national elections this year, which introduces yet another source of volatility to regional markets. The U.S. elections also bear close attention for anticipating potential shifts in engagement with Asia broadly, and China in particular. While U.S.-China tensions seem to have stabilized recently, uncertainty on that front will likely pick up over the course of the election year, particularly around trade policy. However, the structural theme of supply chain redirection and ‘friend-shoring’ seems likely to continue to the benefit of some economies in the region, but this will likely be slow-moving.

Taking a diversified approach of tactically hedging against risks and volatility in the near-term, such as through derivatives and gold, while allocating to structural growth themes in the long-term, is our recommended approach in a dynamic and transitional year for Asia and the world.

All market and economic data as of January 22, 2024 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.

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Index Definitions

The MSCI China Index captures large- and mid-cap representation across China A shares, H shares, B shares, Red chips, P chips and foreign listings (e.g., ADRs).

The MSCI India Index is designed to measure the performance of the large- and mid-cap segments of the Indian market.

The MSCI Taiwan Index is designed to measure the performance of the large- and mid-cap segments of the Taiwan market.

The MSCI Korea Index is designed to measure the performance of the large- and mid-cap segments of the South Korean market.

The MSCI Brazil Index is designed to measure the performance of the large- and mid-cap segments of the Brazilian market.

The World Container Index (WCI) is a composite index of container freight rates on eight major routes to/from the US, Europe, and Asia.