The allure of diversification in Asia

>> Vietnam – rising star in Indo-Pacific

The key question now is whether the Federal Reserve 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% target, making the current yield levels on safe-haven bonds and investment grade securities particularly compelling.

Don’t bet against the US

James Cheo, Chief Investment Officer, Southeast Asia and India, HSBC Global Private Banking and Wealth, said the big question is whether the recent pullback in equity markets is a blip or signals 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 PMIs. “This positive momentum has been reflected in the broadening of cyclical asset performance and in our view, has led to global macro conditions to be more constructive”, said James Cheo.

This also suggests that US equity markets could see further growth. Moreover, diversifying across sectors to include the industrial and consumer goods sector with an improving earnings growth outlook could offer additional opportunities for investors.

Diversification opportunities in Asia

In James Cheo’s view, 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 to portfolio resilience.  Japan's ongoing corporate reforms and technological advancements further bolster its appeal”, said James Cheo.

South Korea to ride on rising 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 the rising demand for 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 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 rewarded.

ASEAN and India – the new AI

James Cheo said 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 in services, particularly IT, India is less vulnerable to global economic slowdowns, further reducing correlations with global economic conditions.

“India has been one of the standout markets in recent years with 8 consecutive years of positive returns. India is already one of the largest economies in the world and is one of the few places with strong demographic growth, driving it to be 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% of corporate revenue comes from domestic sales”, said James Cheo.

>> Vietnam remains on track to better growth prospects

ASEAN offers one of the most exciting structural growth stories in Asia due to its rising middle class and stands to benefit from the diversification of global supply chains. With a population of over 680 million, ASEAN’s middle class is poised to become one of the world’s largest economic locomotives in the next decade.

Indonesia, as the largest economy in ASEAN, plays a crucial role in the region’s structural outlook. The country’s outlook is buttressed by the strength and resilience of its consumers. Indonesia also boasts the world’s largest nickel reserves, a crucial component in electric vehicle batteries, and is expected to move up the value-chain in the manufacturing of electric vehicle batteries.

James Cheo said Vietnam, a burgeoning economy powered by foreign direct investments and its manufacturing prowess, is set to be one of the fastest-growing economies in the region in the years ahead. Strong demographics, infrastructure spending, openness to trade and attractiveness for foreign direct investments will continue to drive Vietnam’s growth. As stock market reforms progress, Vietnam will grow in importance for global investors.

Furthermore, the implementation of the Regional Comprehensive Economic Partnership (RCEP) will further integrate trade and accelerate investments in the region.  

Amidst prevailing market uncertainties, Asia's diverse landscape offers abundant opportunities for investors. By diversifying across different markets and sectors, investors can leverage Asia's growth potential and cultivate resilient portfolios for the future.