Asia ex-Japan equities taking up the baton

Over the course of this summer, US equities were riding high on a combination of strong corporate earnings and forward guidance and expectations that the Fed will start lowering interest rates from September to shore up the slowing economy. The key premise was that tariff-induced inflation was not as bad as presumed.

“Glass half-full” in US equities

The US non-farm payrolls and inflation data for July, though mixed, have sustained those Fed rate cut expectations. US non-farm payrolls were revised significantly lower for May and June and consumer inflation were as per expectations. However, producer price inflation has started to rise due to the higher cost of tariff-exposed goods.

Investor positioning is also very important at this juncture. US equity market correction following the week non-farm payrolls data was short-lived, compared to 12 months ago, when we saw a similarly weak jobs data. This is primarily because investor positioning in US equities was relatively neutral, as opposed to excessively bullish investor positioning in August last year.

There is also tailwind from geopolitics. For example, the US made progress on trade deals with its key trading partners ahead of the tariff deadlines in August. Meanwhile, US plans to step-up sanctions on Russia did not happen, easing some of the inflationary pressures that would have come through higher oil prices.

From a fundamental standpoint, yet another strong US earnings season, powered by accelerating AI investments, has provided support for the equity rally. Guidance from the AI-related technology and communication services sectors remains strong, with the two sectors expected to deliver 19% and 13% earnings growth over the next 12 months.

Optimism increasingly priced in

However, we would like to point out that the MSCI US equity index is trading at a 22x 12-month forward P/E multiple, close to its all-time high. A 12% earnings growth estimate for the next 12 months leaves little room for upward surprises. Investor positioning and sentiment indicators suggest there is still room for upside before they turn contrarian. In contrast, the MSCI Asia ex-Japan and China equity indices are trading at relatively attractive 13.8x and 12.3x P/E multiples, respectively. Given this, it would be prudent to reduce any US excessive long exposure and rotate to Asia ex-Japan, particularly Chinese equities.

Rotating to Asia ex-Japan

China equities take up one-third of the weighting in the MSCI Asia ex-Japan index. The Q2 25 earnings season in China is in its early days, but companies have delivered positive surprises so far, with the technology sector, where the earnings season is more advanced, delivering among the highest positive surprises.

Internet and technology companies have reported strong growth in online and mobile entertainment, as well as demand for AI infrastructure. AI adoption continues, especially in enhancing mobile app features, supporting software development and sharpening digital marketing. This is supporting an increase in capital investment, with a focus on efficient spending. The potential relaxation of US semiconductor chip export rules should further support AI development in China. This should lead to a narrowing in the valuation gap between the Hang Seng Technology index and the Nasdaq-100 index.

AI development is likely to support the broader China equity market, where valuation remains at an attractive discount to global equities. We expect policy stimulus, such as recent plans to support bank lending to consumers, to continue to stabilise China’s growth. Although China’s industrial production, fixed asset investment and retail sales growth slowed in July as front-loading of exports ahead of US tariffs and a consumer goods trade-in programme ended, services sector retail sales and output remained robust.

Against this backdrop, China’s policymakers are likely to remain watchful of incoming data, but they are unlikely to change policies abruptly. We see the government prioritising implementation of the current budget, including accelerating infrastructure investment, facilitating purchases of unsold homes and undeveloped land, and expanding the trade-in programme to services, while preparing a contingency plan to prevent any further economic downturn.

Equity markets move on expectations. It is true that, compared with the doom-and-gloom about China equities about 4-5 months ago due to Trump 2.0 and tariffs, the outlook does not look as bad as feared. Hence, we believe that China equities can do well and outperform the rest of Asia ex-Japan, especially in selected areas such as the technology sector on the back of the AI-wave and relatively cheap valuation.

(Daniel Lam is Head of Equity Strategy at Standard Chartered Bank’s Wealth Solutions Chief Investment Office)

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