Amid the challenges on further tariffs and limited monetary easing ahead, Asia is poised to rely more on fiscal stimulus to support economic growth amid external headwinds.
In brief
- Decades of Asian exporters’ integration into global supply chains have strengthened the growth linkages between Asia and the U.S.
- Domestic demand will be key in driving Asian growth & equities outperformance, particularly with the external backdrop looking increasingly challenging.
- Investors should be more selective within their Asian equity allocations, assessing thematic, policy-driven, cyclical and structural trends.
Asian equities have underperformed their U.S. peers in recent years1 and may face continued challenges through 2025 amid trade tensions and a possibly strong U.S. dollar. In this article, we analyze past periods of superior Asian equity performance relative to the U.S. to identify potential macro catalysts for a reversal of consensus views and will discuss corporate earnings and other fundamental aspects on Asian equities in the upcoming publications.
Seeking alpha
When comparing 12-month rolling returns of Asian and U.S. equities over the past 35+ years, two main observations emerge. First, there were more frequent periods of meaningful outperformances in earlier years, but since the Global Financial Crisis (GFC) in 2008, the two equity markets have largely moved in lockstep. Second, episodes of pre-GFC Asian equities outperformance relative to U.S. equities coincided with a positive real gross domestic product (GDP) growth differential in favor of Asia. This underscores that it is not outright growth, but rather growth differentials that drive capital flows, particularly before the GFC. The stronger integration of Asian exporters into global supply chains has raised the importance of external demand in driving overall growth since the early 2000s.
In recent years, escalating trade frictions have shifted global supply chains, fostering closer trade linkages between China and the rest of Asia. This has resulted in the synchroneity in manufacturing cycles in the U.S., China and the rest of Asia.
The implications are two-folds: firstly, Asia’s growth outperformance versus the U.S. will have to stem from an improving domestic demand picture in the former; secondly, the uncertain near-term environment stresses the need for investors to remain active in Asian equities.
Tracking Asian equities outperformance: now and then
Asian equities are widely considered attractive for the potential added returns (and risks) relative to U.S. equities. In other words, a systematic downturn in U.S. equities would also drag Asian equities, noting their correlation over the past 20 years have stood at 0.81. However, there are pockets of cyclical upsides when Asia could outshine U.S. markets.
- 1993: Asian markets saw increased analyst coverage and foreign investor participation,
- 1999: Internet technology saw rapid advancements,
- Mid-2000s: China’s expansion fueled growth in neighboring economies.
Exhibit 1: A fading relationship between equity market returns and growth differentials
12-month rolling total returns (left) versus real GDP growth differential (right)
Source: FactSet, Bloomberg, MSCI, World Bank, J.P. Morgan Asset Management calculations. Growth differential is relative to the U.S. and weighted by index market capitalization where back-tested data are based on figures at index launch. Performance is in USD total return terms. Data reflect most recently available as of 16/12/24.
While each period had different characteristics, one common thread was the region’s stronger economic growth relative to the U.S. (Exhibit 1). However, this relationship appeared to have faded post-GFC, with Asian equities largely moving in lockstep to U.S. equities regardless of whether Asian economies as a block were expanding faster or slower.
Move from local to global drove growth alpha
Prior to the Asian Financial Crisis (AFC), the Asian region experienced sustained economic growth that was higher than developed and other emerging economies. This was partly due to robust policies that provided a conducive environment for private enterprises and strong investment growth, evident in unprecedented private capital inflows into the region in the early to mid-1990s. Moreover, some Asian economies gradually embraced exports as a growth engine through export credit extension and export targets among other policies. The diversification of both internal and external growth drivers led to growth differentials moving in favor of Asia relative to the U.S., resulting in the outperformance of Asian equities.
The relative outperformance in Asian growth vis-à-vis the U.S, began to decline in the mid-2000s. Since China joined the World Trade Organization in 2001, its global dominance in manufactured goods exports surged, with a growing reliance on its Asian partners for intermediate inputs. This is demonstrated by the increase in intra-Asian trade activity. These manufactured goods are mainly bound for developed economies such as the U.S., resulting in the synchronized business cycles in the U.S., China and the rest of Asia. This culminated in a stronger relationship between the U.S. and Asia returns since the mid-2000s, with certain manufacture-oriented sectors such as industrials, information technology and communication services driving the bulk of the positive returns.
Exhibit 2: Asia’s growing reliance on exports
Exports as a percentage of GDP
Source: FactSet, Bloomberg, MSCI, World Bank, J.P. Morgan Asset Management calculations. Calculations start from 1988, ASEAN are base MSCI AC Asia constituents. Data reflect most recently available as of 16/12/24.
In 2018, another trend emerged with the start of the U.S.-China trade war: the reshuffling of supply chains. Contrary to earlier expectations, in response to the tariff imposition, China expanded foreign trade, demonstrating the re-configuration of global goods linkages (Exhibit 2). There was a discernible pick-up in ASEAN exports to the U.S., as U.S. imports from China declined. While this ongoing trend benefits key Asian exporters, it has also reaffirmed the linkages between Asia and the U.S. Given the growing dependence on external trade for Asian economies, growth in the U.S. and Asia, and as a result, equity performances, will likely move in tandem in the foreseeable future.
Turning inwards: from external to domestic demand
If history is any guide, domestic demand will be key in driving growth outperformance in Asia, particularly as the external backdrop is increasingly challenged by further tariffs. While Asian economies have remained fiscally prudent in recent years, there is room for fiscal policy to turn expansionary should growth momentum decelerate beyond expectations.
An example of this includes the recent supplementary budget announced by Japanese policymakers, which aims to support consumption through the subsidies and higher income tax exemption thresholds2. Meanwhile, investors are turning incrementally hopeful for further fiscal easing from China, noting the considerable change of policy tone to be more supportive of domestic consumption at the December Politburo meeting and Central Economic Work Conference.
Fiscal policy will be increasingly pivotal to bolster growth, given limited room for central banks to ease monetary policies amid financial stability concerns and potentially higher-for-longer U.S. policy rates.
Structural forces remain intact
Beyond the cyclical backdrop, structural pillars such as corporate governance reforms in key Asian markets such as Japan and South Korea and the tailwinds from the demand for Artificial Intelligence (AI) remain intact. Encouragingly, some policies have resulted in concrete improvements in Japan, such as increased dividends and a pick-up in stock buybacks. The combination of a constructive earnings growth outlook and fair valuations in these markets present opportunities for long-term investors seeking exposure to the Asian market. On AI, the focus for investors has mainly been centered on the U.S. mega-cap companies. However, the structural boost for AI-related products and high-performance semiconductors could provide a tailwind for Asian tech manufacturers, particularly in South Korea and Taiwan, which are trading at a discount against the U.S. mega-cap tech names and are paying relatively higher dividends. ASEAN’s growth forces remain evident, including favorable demographics, a growing middle class, and increasing consumption. There is an accelerating change in consumption behavior, aided by increasing financial and digital penetration.
Investment implications
Amid the challenges on further tariffs and limited monetary easing ahead, Asia is poised to rely more on fiscal stimulus to support economic growth amid external headwinds. This implies that domestic demand could be the marginal contributor to overall growth going forward, reviving prior episodes when Asian equity markets provided meaningful excess return to investors. While U.S. equities remain key in portfolios, investors should consider diversifying their equity allocation into Asian markets given the prevailing risks around global growth, stretched valuations and concentration risks in U.S. equity benchmarks.
Asian equities remain attractive given the healthy fundamentals (with consensus expecting 12.8% earnings growth in 2025) and relatively cheaper valuation at 13.2x forward price-to-earnings (P/E) ratio (versus 22.2x forward P/E ratio for the U.S.).
In our view, more opportunities lie within its many constituent markets, with consensus expecting some markets to even reach 19.6% earnings growth over 2025 at a valuations of 8.1x forward P/E ratio. Past performances had indeed showed a wide disparity. The Asian equity diffusion index3, currently reading at 64% over a 3-year return basis, indicates that 7 out of 11 Asian markets had higher returns than the broad index.
Exhibit 3: Wide dispersion in constituent market returns
3-year rolling total return in USD terms
Source: FactSet, Bloomberg, MSCI, World Bank, J.P. Morgan Asset Management calculations. Constituent markets include Japan, China, India, Taiwan, Korea, Hong Kong, Singapore, Indonesia, Malaysia, Philippines and Thailand. Data reflect most recently available as of 16/12/24.
Moreover, the wide dispersion in returns illustrates the need for an active approach to this market, with the top performing market returning 18.6% p.a. higher than the worst market over the past three years, a pick-up from the late 2010s level (Exhibit 3). As such, against the backdrop of growing disparity between individual constituent market performances, investors should be more selective within their Asian equity allocations, taking into consideration the thematic, policy-driven, cyclical and structural trends.