Japan: Multiple positive tailwinds for the market

We continue to believe that Japan is likely to maintain its pole position in trade negotiations with the US, especially with the announcement that a mutually beneficial deal could be reached as early as June. This could provide a near-term upside to Japanese equities. In the longer term, corporate reforms continue to gather momentum, with buybacks and restructuring exercises to positively drive the market further. We also believe that the country has likely passed peak tariff concerns even as markets remain volatile.

In Japan, monetary policy remains significantly accommodative and is likely to continue supporting growth and corporate margins. Meanwhile, as of 30 April, the Bank of Japan has kept rates steady for the second straight meeting. In our view, the defining moment for Japan is its structural shift from deflation to sustainable inflation since 2023. We expect a virtuous cycle of sustainable inflation, wage growth, and earnings growth, with two consecutive years of above 5% wage hikes as companies raise prices and drive an expansion of margins and earnings on operating leverage. 

In the long term, the most compelling element of the Japanese equities investment thesis is the corporate reform of the Tokyo Stock Exchange. Amid record-high buy-backs, we expect efforts by companies to drive long-term shareholder returns and value creation to both pick up in pace and broaden in scope, as the benefits of stronger corporate governance gets reflected in corporate valuation multiples. Japanese equities are also trading at an attractive level in absolute terms, demonstrating superior earnings growth versus major stock markets.

Asia: Downgrading Taiwanese and Thai equities

Ongoing trade tensions are expected to significantly impact earnings growth for Taiwan and Thailand, given their open economies. In addition, Taiwan has outsized exposure to the US, so the odds of a recession have increased. Asian markets have considerable exposure to the US and are vulnerable to weaker US demand. Within North Asia, Taiwan has the highest revenue exposure to the US, at close to 40%, mostly through cyclical sectors like technology hardware and semiconductors.

The sudden surge in the Taiwanese dollar (TWD), to its strongest level in three years, will have negative implications for the island’s exporters, while recent developments in domestic politics at the Legislative Yuan are unlikely to be helpful to market sentiment. We expect further consensus earnings downgrades for Taiwanese equities, which, in our view, have not yet been fully priced in. Hence, we have downgraded Taiwan from Overweight to Neutral. 

Thailand is one of the region’s most open economies, with trade accounting for 137% of GDP in 2024. Punitive reciprocal tariffs of 36% are expected to dent GDP growth when the blanket exemption lapses in July, while stalled tariff talks between the US and Thailand due to lèse-majesté charges against an American academic is a drag on the de-escalation of tensions. Over the longer term, Thailand continues to grapple with the ramifications of China’s manufacturing glut given its high dependence on exports from China, which has resulted in a contraction in the Thai manufacturing sector. 

Currency volatility: What’s next for Asian markets?

Asian currencies shot up at the end of last week after rumours of possible trade talks between the US and China circulated. The surge was led by the TWD, which has outperformed by roughly +8% since 1 May, posting the biggest intraday gain in the last 40 years. The TWD appears to have been additionally boosted by US technology earnings, which fuelled expectations for semiconductor exports, as well as the hope of a possible US-Taiwan trade deal.

A potential trade deal could include the currency being removed from the US Treasuries’ watchlist for FX manipulators, where it has been for the last three years due to its large trade surplus with the US and its managed float exchange rate regime. The Chinese Yuan (CNH) itself, with a lower volatility, has recovered to the USD/CNH 7.20 levels, which is a new high since November of last year. With that, from a year-to-date perspective, Asian currencies have partially closed the gap to other currency clusters, which initially benefited more from recent dollar weakness due to the US focusing its effective tariff implementation on China. It remains doubtful that the perceived decline in trade risks between the superpowers is a sustainable opportunity for Asian emerging market currencies.

We maintain a cautious outlook on Asian low-volatility currencies. In particular, we see continued downside risks for the Chinese yuan, where trade headwinds will eventually translate into weaker economic data, and stick to our Bearish short-term outlook.

What do we see moving forward?

As with any long-term shifts, the challenge for investors is to keep an open mind, since the patterns may not exactly play out in the exact same manner that history would suggest. So the days and weeks ahead will be about looking for evidence from policymakers on whether the baton is being passed from the US to the rest of the world, most notably to Europe and China. While we do not expect the US Federal Reserve to yield to political pressure yet, the odds are rising that the pause in rate cuts will end soon. At the same time, this opens opportunities for stimulus in China, or for policy self-help in Europe in the wake of the newly formed German government. While looking out for signs of major policy shifts, we suggest some housekeeping in Asian equities. We reiterate our positive view on Japan while downgrading Taiwan and Thailand.