Fundamental risk-reward for China and Hong Kong equities has reached a positive turning point, and we believe a confluence of factors warrant an upgrade to an Overweight stance for the region.

This results in an upgrade of our position in Asia ex-Japan equities from Neutral to Overweight. Together with our Overweight position on Japan, we are positive on Asian equities as a whole.

We maintain Neutral positions on US and European equities. We do not rule out the possibility of markets overshooting for US and Europe as the artificial intelligence (AI) narrative remains dominant and recession fears recede.

US – Positive near-term tailwinds

The timing of Fed rate cuts is highly uncertain and still dependent on incoming data.

What has been noteworthy is the fact that the S&P 500 Index has continued to outperform the S&P 500 Equal Weighted Index in May. This indicates that the mega cap names continue to gain favour with investors on a relative basis. Part of the reason for the S&P 500 Index’s outperformance is also due to the strong set of results from Nvidia, which has helped to spur a re-rating of the broader US semiconductor complex.

Meanwhile, the consumption outlook appears to be largely holding up still, with the Conference Board index of consumer confidence increasing in May. However, lower-income cohorts in the US appear to be facing headwinds, with Coca-Cola’s management noting that “some purchasing power compression” is seen in this segment of the market.

We maintain our Neutral position on US equities at this juncture. In the near term, we do not rule out markets overshooting as the AI narrative remains dominant and recession fears recede. Greater evidence of disinflation could also give further support to risk assets.

Europe – Election season

It is a busy period for Europe - with the EU Parliament Elections, various country elections such as Italy’s and Belgium’s in June, as well as the UK elections in July.

In the EU, polls have been forecasting a shift towards the right and there is potential for green and social policy to evolve, with increasing priorities on defence.

In the UK, polls show that the Labour Party is well placed to win the next UK elections. We see abundant equity opportunities in the UK given its significant discount versus other markets. Moreover, sentiment would be supported should there be a period of political stability, with structural reforms under a Labour government. This comes after an extended period of political uncertainty since the Brexit vote back in 2016. Rishi Sunak, the current prime minister, is the third Tory leader to lead the UK government in the last couple of years.

While Labour’s policies could be a drag on industries like Energy and Transportation, we think that overall, a Labour government could usher in political and economic stability and the focus on improving supply side dynamics is positive.

Japan – Soft economic data and earnings guidance offset by continued corporate reforms

The Japanese equity market produced a muted performance in May, as soft 1Q2024 GDP data and underwhelming earnings guidance were offset by continued positive momentum from ongoing corporate governance reforms such as share buybacks and dividend increases.

Japan’s economy shrank an annualised 2% in the January-March period from the previous three month, although BoJ governor Kazuo Ueda highlighted that the economy was still on track for a moderate recovery. Meanwhile, initial guidance provided by Japanese corporates for the new fiscal year (financial year ending 31 March 2025) for recurring profits came in weaker than consensus expectations. On the other hand, we note continued positives on governance-related announcements, such as an acceleration of share buyback commitments and dividend increases as compared to past trends.

Asia ex-Japan – Upgraded to Overweight

We have put China and Hong Kong equities on positive watch for some time and now believe that the fundamental risk-reward of the region has reached a positive turning point. We are upgrading our stance on China and Hong Kong equities from Neutral to Overweight, which results in an upgrade of our position in Asia ex-Japan equities from Neutral to Overweight. Though there could be some profit taking after a rebound of more than 20% from its trough in mid-January, we believe that the recovery for Hong Kong and Chinese equities is still broadly in an early stage and expect more gains over the medium to long term.

US-China geopolitical risks remain a concern but given that it has been six years since the US-China trade war started in 2018, we see some signs that investors have by now priced in a higher resting heart rate of China-related geopolitical risks. Within China equities, we favour undervalued names providing exposure to the AI theme, large market leaders, and quality yield names.

Across Asia ex-Japan, we are also positive on South Korea, Singapore, and Indonesia equities. Together with our Overweight on Japan, we are positive on Asian equities.

The downward earnings revision cycle for the MSCI Asia ex-Japan Index has likely bottomed, in our view, and we expect earnings per share (EPS) growth of 23% in 2024 and 16% in 2025.

China/HK – Positive policy pivots

Shortly after the April politburo meeting, the issuance schedule of the CNY1 trillion ultra-long special treasury bonds and a series of supportive measures were announced, including the recent real estate policy. Among these measures, the magnitude of the reduction in downpayment ratios exceeded market expectations, while Tier 1 cities also announced and implemented easing measures.

We believe the real estate policy easing would accelerate the bottoming of the real estate cycle and could help stabilise household confidence and consumption given that real estate accounts for about 60% of households’ assets.

The Hang Seng Index and MSCI China Index outperformed the CSI 300 Index in May. We expect market performance to be largely driven by earnings revisions going forward. On a market cap weighted basis, reported earnings beat consensus estimates by 7% in 1Q2024, driven by solid results from the internet and platform companies which are heavyweights in the indices.

We upgrade our stance on China and Hong Kong equities from Neutral to Overweight. While we prefer A-shares over the medium term, we favour offshore Chinese equities in the near term given its sizeable exposure to internet and platform companies and potential dividend tax cuts. Meanwhile, geopolitical tensions will remain under the spotlight as the US presidential election approaches. We would also look out for the EU’s decision regarding potential tariffs on Chinese electric vehicles.

Global Sectors - Look beyond the headline moves

The Information Technology and Communication Services sectors outperformed in May, extending their lead year to date (YTD), while Energy and Consumer Discretionary lagged.

Despite this, we see significant divergence in sub-sectoral moves beyond the headline numbers. For instance, in Global Energy, Chinese energy names continue to outperform their global peers by a wide margin, supported by a confluence of factors such as solid company execution, industry and SOE reforms, and potential dividend tax exemption plans that may benefit high yielders in H-shares like the energy names.

On the other hand, in the renewable energy space especially in solar, we see US names faring much better given the severe oversupply in polysilicon (affecting Chinese players) and tariffs in place to protect the US domestic industry resulting in a decoupling of average selling prices between US and international prices.

With regards to our sector preferences, we maintain Overweight positions in Information Technology and Communication Services, Materials, Consumer Staples and Healthcare, and maintain an Underweight position in Financials.

Tech – All about Nvidia

China internet stocks performed well in May, benefiting partly from the rerating of China/HK equities. We remain cautiously optimistic on domestic e-commerce should the macro picture improve, while names leveraged to online gaming can continue to benefit from solid game pipelines. We continue to expect international expansion to become an increasingly important growth engine for the sector as some internet verticals in China become increasingly mature.

The semiconductor complex has seen a strong rally in May, outpacing the other tech subsectors. This was in part due to Nvidia’s stellar 1QFY2025 (financial quarter ending 28 April 2024) results and encouraging management commentary, as the company remains the clear winner in the race to build out generative AI capabilities. Demand continues to be evident from cloud computing leaders as they support their customers in building AI models, as well as from enterprises, consumer internet leaders, and sovereign governments. This is a clear positive development for the rest of the AI semiconductor complex as the durability of AI demand remains firm despite increasingly higher investor expectations.