Equity investors are looking at China’s neighbors – South Korea, Japan and India

China’s weak economic recovery after emerging from strict “zero-Covid” lockdowns has caused weaker sentiment towards the country, prompting investors to look to alternative options – such as its close neighbours.

In particular, stock markets in Japan, South Korea and India have benefited greatly from the disappointment of China’s reopening, highlighted by softer-than-expected data from the world’s second-largest economy.

“In China’s weakness, investors have looked elsewhere in the region for opportunities,” Goldman Sachs Asia-Pacific chief economist Andrew Tilton said in a research note on Friday, adding that Japan “is in the spotlight” while India “has also returned to focus in recent months.”

The Nikkei 225 is in bull market territory, up more than 23% so far this year thanks to garnering interest from foreign investors, including Berkshire Hathaway’s Warren Buffett.

India’s Nifty 50 index is up nearly 7% so far this quarter, paring all its losses from March lows, while South Korea’s Kospi index is up 18% so far this year.

This shows a strong contrast to a sell-off in the Chinese stock market. The CSI 300 index, which measures the biggest companies listed in Shanghai and Shenzhen, has fallen 5.29% so far in the quarter, erasing all the gains seen earlier in the year, as shares rallied on reopening momentum.

The Hang Seng Index also touched bear market territory last month and is down nearly 2% year-to-date, Refinitiv data shows.

“Investor sentiment on China has weakened further and, in our view, is around rock bottom levels we have only seen a few times over the past decade,” Goldman Sachs’ Tilton said in the note.

Foreign investors have undoubtedly been key to driving the Japanese market, maintaining the highest levels the Nikkei has seen since 1990.

The latest data from Japan’s Finance Ministry shows that foreign investors continue to build on their Japanese stock positions as domestic investors remain net buyers of foreign bonds.

Foreign investors bought a net 342.18 billion Japanese yen ($2.45 billion) of stocks in the week ended June 2, according to a Reuters tally, for a total of about 6.65 trillion yen of net purchases of Japanese stocks this year. In the same period last year, foreign investors had net sold approx. 1.73 trillion yen.

Wall Street banks including Morgan Stanley and Societe Generale are among those bullish on Japanese stocks, holding “overweight” positions.

In its mid-year global outlook, Morgan Stanley predicted that Japanese stocks will outperform their global peers: “Japan is our most preferred region, with improved equity [Return-on-Equity] and a superior EPS [earnings per share] outlook,” Chief Investment Officer Mike Wilson said.

The firm raised its estimates for the Topix index to rise 18% by June 2024 from its previous target of a 13% gain.

“Japan [is] looks even more attractive, while we have a preference for EC [emerging markets] versus the US and EU,” Morgan Stanley strategists said in a note, adding that “accelerating regional growth and solid domestic GDP should support earnings” for Japanese companies.

South Korea is another closely watched market as concerns over China’s recovery linger.

Korean technology stocks, which make up about half of the Kospi 200 index, have been the main driver behind UBS Global Wealth Management’s “most preferred” status on the sector and market.

Noting that the bank expects U.S. interest rates to peak soon followed by a fall in the U.S. dollar, UBS wrote in its monthly outlook: “We remain most bullish on Asia semiconductors over the next 3-6 months and Korea, as we have done in the past. highlighted as a winner in such an environment.”

South Korean tech stocks’ low price-to-book ratios make it “an attractive alternative to more expensive tech segments,” UBS said, noting there remains “significant value” in China’s e-commerce stocks, which have plunged 20% year-to-date . Price-to-book ratio is an important metric used by traders to measure the value of a stock.

“For China, questions remain about the durability of the economic recovery. This, and ongoing geopolitical concerns, have weighed on the market,” UBS strategists said in the report.

Goldman Sachs is also confident in the South Korean market, and expects more foreign investments in the future.

“We are relatively bullish on Korea, both because we are less concerned about broader domestic spillovers from weakness in the housing sector and more optimistic about foreign portfolio inflows,” Goldman’s Tilton said.

The Bank of Korea, meanwhile, is expected to be one of the first central banks to deliver a monetary policy pivot, despite its governor Rhee Chang-yong telling CNBC it is still “too early” to discuss a rate cut.

Banks including Citi and Nomura expect to see a rate cut of 25 basis points as early as the third quarter of this year.

South Korea’s money market funds (MMF) hit a record high in late May, data from the Korea Financial Investment Association showed. Total MMF assets under management stood at 172.7 trillion South Korean won ($134 billion), or an increase of 22% since the end of September last year.

A money market fund is a type of fund that invests in highly liquid instruments in the short term, including cash, and is seen as a safe haven in the midst of a volatile market.

Fitch Ratings senior analyst Chloe Andrieu said in a June 8 note: “The increase was driven by institutional investors turning assets towards high-quality investments, such as MMFs,” adding that rising interest rates worldwide have also contributed to the shift.

In contrast, newly launched funds in China marked the smallest holdings since 2019 for the first five months of this year, after raising 432.1 billion Chinese yuan ($61 billion), according to data from local consultancy Z-Ben Advisors.

There is also growing interest in investing in India, according to Goldman Sachs.

“Customers are increasingly asking about India’s potential to benefit from greater investment amid supply chain reconfiguration,” Tilton said. The firm said it is “broadly positive over the medium term,” citing India’s continued monetary policy, credit conditions and its prospects for attracting foreign direct investment.

HSBC’s chief economist for India and Indonesia, Pranjul Bhandari, said ahead of India’s central bank’s June meeting that keeping interest rates unchanged would be “allowing the perfect macro mix to continue”, pointing to increased growth and reduced inflation forecasts.

The firm also raised India’s full-year gross domestic product forecast for 2024 from 5.5% to 5.8% and expects the RBI to deliver two rate cuts in the first quarters of 2024, bringing the repo rate to 6% by mid-2024.

“India’s economy is much improved from a year ago,” Bhandari said. “GDP growth momentum has been flat according to the latest high-frequency data, with the informal sector picking up the slack as formal sector growth softens,” she said.

The Reserve Bank of India kept its benchmark interest rate steady at 6.50% last week for the second time in a row – in line with market expectations.

The Organization for Economic Co-operation and Development also expects India’s economic growth to outpace China’s this year and next, it said in its latest global outlook report.

“Growth has surprised on the upside recently and we think a better informal sector is at the heart of that,” Bhandari said. “Increasing government public spending, and some cushion in the government budget to support social welfare schemes, is likely to continue to support demand from the informal sector.”