The conventional saying “when the U.S. sneezes, the rest of the world catches a cold” suggests that given the U.S.’s sheer size and global economic linkages, a U.S. slowdown or equity market pullback could have severe spillovers globally.

So far this year, the S&P 500 saw a -3.8% drawdown while MSCI APAC ex-JP remained resilient with a 5.5% return, as fading U.S. exceptionalism revived interest in non-U.S. markets. While it is not our base case for a sharp U.S. recession or bear market, investors may question whether Asian equities can maintain their relative outperformance if it occurs, or if risk-off sentiments trigger a larger drawdown in Asia compared to the U.S.

While spillovers are unavoidable, there are reasons to believe that this time round, if the U.S. sneezes, Asia could see a smaller drawdown given current valuations and economic factors. In other words, APAC has a mask on this time.

Did Asia catch a cold in past episodes?

The rise of globalization since the early 2000s has led to increasingly integrated trade and financial linkages globally. Since then, the correlation between the S&P 500 and MSCI APAC ex-JP has averaged around 0.7. However, as seen in Exhibit 1, the correlation has not been stable, with periods of weakening during downturns (e.g. the aftermath of the Dotcom Bubble, the 2008 Global Financial Crisis and the COVID pandemic). The latest 5-year correlation has also fallen to 0.41.

During U.S. bear markets

If we focus on periods of over 20% drawdown in the S&P 500 (typically interpreted as bear markets), MSCI APAC ex-Japan indeed experienced negative returns each time. However, in 5 out of 7 instances, APAC outperformed the U.S. (Exhibit 2). The notable exception is the 2008 Global Financial Crisis, but we do not expect a crisis of similar severity to happen this time if U.S. slips into a recession. During that episode, the APAC valuation discount was also the narrowest relative to the U.S. (4%). 

Other episodes of APAC outperformance have coincided with larger APAC valuation discounts, which are more similar to current levels (a 35% discount against the U.S.). APAC’s current forward price-to-earnings (P/E) ratio of 13.5 is also close to the 15-year average of 12.9, while the U.S.’s 20.3 is still materially higher than the average of 16.7, despite the year-to-date pullback. Although APAC valuations could remain under pressure in the near term until further policy clarity, the risk of  significant de-rating from here is arguably limited.

Recovery after U.S. bear markets

To the right of Exhibit 2, the 12-month performance following the end of the U.S. bear market indicates a stronger rebound in APAC markets compared to the U.S., except during the exceptional artificial intelligence (AI) rally in the U.S. in 2023.  While it is difficult to time the inflexion points in markets, patient investors who stay invested in APAC markets are often rewarded well following a U.S. market recovery.

This time around, APAC has a mask on

While historical relationships and current valuations only serve as a guide, there are idiosyncratic factors to suggest APAC could be more cushioned from a U.S. downturn:

• Monetary easing: With inflation now at or below target in most Asian economies, central banks have more room to cut rates, especially as U.S. dollar strength becomes less of a concern. Meanwhile, in the U.S., inflationary risks from tariffs could constrain the pace of monetary easing.
• Fiscal easing: Markets such as Japan and Korea have swiftly unveiled stimulus packages to ease tariff impacts, and further supportive measures are expected from China. Meanwhile, U.S. President Trump is seeking USD 163billion spending cuts for FY2026 in his latest discretionary budget blueprint.
• Re-allocation of capital: As U.S. exceptionalism fades and investors diversify beyond the U.S., there is room for capital to be re-allocated or repatriated back to APAC markets.
• The U.S. dollar: A steadily weaker USD (in the event of a U.S. slowdown or other factors) has historically supported Asian equities through increased capital flows, lower cost of USD debt etc. It is possible a U.S. downturn could also trigger safe haven demand, putting upward pressure on the USD. However, we think the rush for the USD could be less pronounced this time (i.e. the left tail of the USD smile further away) given the risk event is occurring within the U.S., and the expectation is for a growth slowdown or a mild recession, rather than a severe crisis.

Investment implications

Based on historical experience, APAC’s attractive relative valuations, and the ability for domestic policy to partially offset external storms, there is reason to believe APAC can remain relatively resilient if the U.S. experiences a significant downturn (although this is not our base case). The subsequent recovery can potentially reward patient investors, making the case to stay invested while positioning defensively.

Near-term market volatility and an economic slowdown in Asia are inevitable if tariff risks remain. However, in the long run, tariffs could accelerate existing trends ,such as increasing intra-regional trade, supply chain diversification across Asia, and a policy focus on strengthening domestic demand. Beyond trade, structural themes in APAC, such as digitalization and AI, could see increasing tailwinds as investors look to diversify their technology exposure outside the U.S.

On an index level, within the MSCI APAC ex-Japan universe, China (28.71%) and India (18.65%) make up nearly 50% of the index. Both markets have exports to the U.S. accounting for less than 3% of their gross domestic product and have a large and growing domestic market along with idiosyncratic policies. As these markets grow in index weights, the correlation between the U.S. and APAC markets may gradually weaken.

Thus, APAC remains an important diversifier as investors seek to rebalance portfolios, while capturing long-term structural tailwinds and taking comfort in more reasonable valuations.

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