Japan, AI and rate cuts

While the world grapples with renewed fears of a global recession, analysts say Asia stands out as the region to watch and could outperform the broader global market.

At first glance, Asian stocks as a whole have more modest gains so far this year compared with their U.S. and European counterparts. The MSCI International All Country Asia Pacific index is only up 4.71% year to date, versus the broad-based S&P 500 and the pan-Europe Euro Stoxx 600, which are up 13.25% and 6.65%, respectively.

But Asia is more economically diverse than Europe and the U.S., and there are still bright spots in the region, especially in Japan and South Korea.

Earlier this month, Nomura said Asia is likely to outperform in the medium term as “the prospect of subdued global growth and the near-end of policy rate hikes are likely to spur investors to look for new opportunities, while placing a premium on healthy economic fundamentals.”

It added Asian economies “by and large” avoided qualitative easing on a large scale, leaving the region in better stead in terms of fiscal sustainability, inflation challenges and financial system health.

While the Nomura analysts expect China’s economy to slow, they expect GDP growth in Asia will “sustainably” outperform other emerging markets and the U.S. — with India and Southeast Asia set to be the fastest growing economies this decade.

This view is also shared by analyst Daniela Gombert from asset management company DWS, which said that “over a horizon of twelve months, Asian and European stock markets appear to be much more promising than the U.S. market.”

Specifically for Asia, Gombert points at the Japanese stock market, saying that “Unlike roughly 30 years ago, valuations are far from being as exaggerated as they used to be back then. Generally speaking, Japanese stocks allow investors to become part of the Asian growth story.”

As most of Asia recovered from the pandemic, Japan’s markets led gains, with the Nikkei 225 up almost 25% year to date and the broad-based Topix up by about 21.5%.

The firm said China’s reopening and the return of tourists should bode well for Japan. As such, Gombert believes that “Japan should be a quite interesting market for investors, even if prices have already had a good run short-term.”

The Bank of Japan will also be closely watched, after Governor Kazuo Ueda took the helm earlier this year. Ueda is widely expected to walk the BOJ out of its ultra-dovish monetary policy, although he has made no changes to the BOJ’s policy thus far.

Private banking company Lombard Odier noted that headline inflation in Japan has rebounded, and that wage negotiations in the spring delivered one of the highest base pay rates in recent decades.

The firm also expects “another year of above-target inflation in 2023” and predicted the BOJ will respond by ending its “yield curve control” policy later in the year.

During the central bank’s June meeting, one policymaker said that a “revision to the treatment of yield curve control should be discussed at an early stage,” the first time a BOJ summary of opinions showed an explicit mention of the need for a “revision” to the YCC policy. 

In April, the BOJ announced it will conduct a “a broad-perspective review of [its] monetary policy,” which could span 12-18 months. But Lombard Odier still expects the BOJ to end the yield curve control policy before this review is over.

While the U.S. Federal Reserve has signaled it could raise rates by another 50 basis points before year end, Morgan Stanley predicted that inflation has peaked in most economies in Asia, noting that almost all central banks in the region have paused their rate hike cycles.

“We think this pause is durable and in fact further disinflation opens the room for rate cuts as central banks don’t need to let real rates rise into restrictive territory,” the team of four economists wrote in a note earlier this month.

Morgan Stanley said the disinflation process in Asia “is well underway” and it expects inflation to move back to within target ranges for 80% of the region in the next three months.

As such, it expects Asian central banks to be able to cut rates even ahead of the Fed, with the early movers, like Indonesia, acting as soon as the fourth quarter of 2023.

Technological developments are another reason for optimism in Asia. With the advent of generative artificial intelligence like ChatGPT from OpenAI, Google’s Bard and Baidu’s Ernie Bot, attention has also turned to the hardware powering these AI tools, i.e. semiconductors.

Countries have plunged massive subsidies into building chip plants and boosting semiconductor production, such as the U.S. Chips Act, which will provide $280 billion in subsidies over the next decade.

Lombard Odier senior equity research analyst for tech Marco Barresi highlighted that Japan, South Korea and Taiwan also provide tax credits and subsidies.

Furthermore, despite restrictions on China from the U.S. on obtaining advanced chip technology, Barresi said China is working on support for its semiconductor industry, which could amount to an estimated $143 billion worth of subsidies over five years.

Barresi added AI will create a new generation of tech startups and applications, just like how “the arrival of the iPhone built an entire industry around mobile applications, and the rise of cloud computing created a new sector of software companies.”

He also points out that almost a third of global semiconductor revenue in 2022 was in the most sophisticated computing chips — and Asian firms account for most of the production of these advanced chips.

Two Asian companies dominate the production of these advanced chips, namely, Taiwan Semiconductor Manufacturing Co and South Korea’s Samsung Electronics.

Barresi writes, “We prefer semiconductor producers serving the cloud market, and so exposed to developments in AI, or electrification. This fits well with our general preference for quality technology companies as the economic cycle evolves.”