Global equity markets have continued to grind higher in the second quarter. Valuations of the US equity markets, particularly for mega technology stocks, have already priced in the growth potential underpinning the Artificial Intelligence (AI) theme. Therefore, we see limited upside potential for developed markets as we face a likely economic slowdown in 2H 2023 or early 2024. In Asia, performance of China equities has been disappointing this year and there are few catalysts to drive markets higher despite attractive valuations. Therefore, we prefer Japan and India equities on a relative basis. We also see opportunities in bonds due to attractive yields and as a hedge to equity risks.
RISKS ELEVATED IN DEVELOPED EQUITIES MARKET
1. Global equity markets have continued to grind higher in the second quarter on i) easing inflationary pressures, ii) stabilization in the global banking sector, iii) resolution of the US debt ceiling, iv) a pause in US interest rate hikes, and v) a general believe that AI would bring transformative growth to the global economy. The dominance of the AI theme is particularly pronounced in the US equities market with the AI-related stocks, case in point being Nvidia, driving the bulk of the gains in the US equities market.
2. We are positive that the current developments in AI could drive an acceleration in innovation and longer-term productivity gains, but the more immediate risk of a significant economic slow-down from the lagged impact of interest rate hikes over the past year should not be underestimated. We are already seeing growth headwinds from Europe and China – the Eurozone economy is losing momentum after a strong first quarter in 2023 due to the tailwinds from declining energy prices, while China’s weak April activity data suggests that its post-COVID recovery could have stalled amid worsening geopolitical tensions. As such, we reiterate caution for the developed equities markets especially when market breadth is narrow, and valuations are elevated.
CHINA’S GROWTH SLOWING
3. China equities performance this year has disappointed investors, post reopening of its economy in October last year. Indeed, second quarter economic data on consumption, manufacturing, and exports has stalled. We believe that several catalysts are required for a rejuvenated rally in China equities: i) better economic data that suggests sustained growth momentum, ii) announcement of more economic support policies by the Chinese government, and/or iii) improving geopolitical relationship with the US.
4. On a longer-term basis, we remain positive on China equities due to its growth trajectory and attractive valuations. We see near term trading opportunities during the Politburo meeting in July on potential announcement of awaited stimulus by the Chinese government.
OPPORTUNITIES IN JAPAN AND INDIA EQUITIES
5. There has been renewed interest in Japan and India equities markets of late. This is reflected in the record purchase by foreigners of JPY5.5 trillion worth of Japanese equities in the last quarter. We have expressed our optimism behind Japan and India equities in our latest market updates.
6. In essence, there are two key reasons why we are positive on Japan equities. First, companies have become more proactive in increasing their dividends and share buybacks to improve their capital efficiency as requested by the Tokyo Stock Exchange. Second, Japan is finally exiting from its deflationary phase and wages are rising at rates not seen since the 1990s – we believe this will drive consumption and growth in the domestic economy.
7. India is undergoing a manufacturing renaissance, poised to become a potential factory of the world. The Modi government has also undertaken a series of positive reforms to cut red tapes, streamline their tax codes and improve infrastructure to attract foreign direct investments. Furthermore, India’s burgeoning middle class is but the beginning of a multi-year economic tailwind for India.
OPPORTUNITIES IN BONDS
8. We see better risk-reward opportunities in bonds relative to equities. We prefer short duration, higher quality bonds as yields are attractive and they offer the potential for capital appreciation should we enter a recession.
9. We also see selective opportunities in certain Asian credits with spreads in certain segments still wide as investors may not have fully returned on concerns over yield volatility. Despite concerns of a slowing Chinese economy, we believe that the potential of major credit risks for the rest of the year remains low.
Figure 1: Valuation and consensus earnings forecast
Source: Thomson Reuters, 23 June 2023, Note: F – Consensus Forecast, x – excluding, P/E – Price to Earnings
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