The year began with high hopes for Japanese shares. The Nikkei 225 Index broke its 1989 high in early 2024 and lurched to another all-time high in July amid low valuations and investor-friendly reforms. Then that soured as the Bank of Japan tightened credit at the end of July, just as weaker-than-expected economic data hoisted expectations of a rate cut in the United States.
China, meanwhile, had enough of its own bear market. Beginning in late September, it unleashed an array of measures to stimulate demand and lift prices. Nevertheless, the specter of tariffs from the incoming Trump administration in the US is giving the markets pause.
We checked in with two Morningstar experts on these subjects: Lorraine Tan, director of equity research, Asia, and Kai Wang, senior equity analyst. Both look after market strategy from their Singapore base. Here’s a condensed, edited version of our conversation.
Leslie Norton: Let’s cast our eyes back on 2024. Asian markets were generally higher. What do we need to keep in mind going forward?
Lorraine Tan: We came off a very strong 2023 for Japan. That reflected the drop in the yen and better competitive positioning for Japanese valuations. The Japanese market took a breather this past year but should still end 2024 with a decent return. With US interest rates coming down, people were expecting the yen to appreciate somewhat off the lows, and you did see folks take some money from the Japanese market. But with Trump’s election win, the market expects interest rates to stay higher for longer, and I think this has kept the yen down and Japanese shares stable.
The sector that is still a beneficiary of the exit from a net zero interest-rate policy by the Bank of Japan is the financial space. We’re still expecting the banks to continue to be able to raise their returns on equity going forward. We still expect a gradual rise in interest rates in Japan now that the yen has weakened, which is more of the US dollar appreciating over the past few weeks. Obviously, with Trump winning the US election, there’s the expectation that US interest rates are going to stay more elevated over a prolonged period. That’s giving strength to the US dollar. That’s not necessarily a bad thing for Japanese companies, which are exporters for the most part. But it’s inflationary for Japan. So, for companies that have a larger share of domestic earnings, there is concern over the ability to pass on costs because the expectation is that wages will rise. Now, the reflationary story in Japan is actually positive for the market. Domestic consumption has been a bit stronger than expected. People have been able to benefit from some of the wage rises as well.
Norton: Was 2024 the pause that refreshes for Japan? Are the bullish factors, including cheapish valuations, and attempts to be more shareholder-friendly, intact?
Tan: Valuations for Japan are less cheap than in early 2023 before everything ran up. There are still pockets of value and opportunities in some very high-quality companies. Japan has some very moaty companies. The companies that lagged and that we continue to like are those with some exposure to China’s economic growth, dependent on the recovery in China. These include factory automation names such as Fanuc 6954 and Harmonic Drive Systems 6324 as well as brands such as Shiseido 4911. For Japan, the discount to our fair value estimates is in the mid- to high single digits. For China, it’s a 15% to 20% discount to our fair value estimates.
Norton: This gives us a great segue into your outlook for China.
Kai Wang: This long period of weak macroeconomic performance gave China room to launch stimulus measures in late September. The outlook was a lot more enthusiastic then. [In late September, the People’s Bank of China and other financial officials launched easing measures including rate cuts, homebuying incentives, cash for banks, and plans to consider a stock-stabilization fund. That was followed in November by a CNY 10 trillion ($1.4 trillion) package over five years to tackle the “hidden” debt of local governments, which still fell short of some people’s expectations.] At first, it looked like a bazooka stimulus package, but what we’re seeing now is that things are a little bit more measured. Given that as the background for 2025, there are still lingering headwinds from the existing weakness in 2024.
At Morningstar, we prefer service-heavy sectors like travel or sectors that deal with consumers trading down. For example, the average meal order is about CNY 45, or about $6, which is a good 20% to 25% lower than last year.
Same with travel. International travel is coming back, but people prefer lower-star, cheaper accommodations. For retail and consumer discretionary names, we see discounts to fair value of about 20% to 25%. We are expecting a 2025 midyear recovery there for some stabilization of consumer confidence. So, we tell people to stay invested in some of the consumer discretionary names because when they come back, you will see outperformance.
Tan: At the end of September, the rebound was so sharp that we went from a discount of 15% to 17% to our fair value estimates on those shares overall to just 4%, based on pure sentiment. There’s a lot of confidence at the moment. That’s why you’re seeing some folks keep some allocation in China shares, even if there have been no new meaningful details on the fiscal policy that people are hoping for.
Norton: What do you expect?
Tan: The government has already indicated they will take steps. They’ve already announced quite a bit on the real estate side. We expect real estate property prices in China to start to bottom by mid-2025 because the excess inventory levels are coming down. Governments are buying excess inventory, and there have been limited new property launches because many real estate companies don’t have the funding.
And some of the measures will allow some of the infrastructure projects to be kicked off. Local governments did not have the cash flow to fund much in 2024. Now, some CNY 10 trillion has been raised, and a lot will be allocated to local governments. That’s going to filter through in the first half of 2025. Hopefully, it will be value-generating. That’s always the concern with fiscal spending.
Wang: I’ll add a caveat to that. It depends on how fast the government can implement some of these measures. Tangible action trickles down to sentiment. For the fourth quarter, bigger companies like Baidu BIDU, PDD Holdings PDD, and Alibaba Group BABA gave pretty muted outlooks. Baidu’s guidance was for the advertising side, and advertising is a proxy for real estate. A lot of offline sectors are seeing a negative year for advertising. The recovery timeline depends on how fast they’re able to implement some of these measures.
Norton: What measures must they implement right away?
Tan: The two biggest are restoring consumer confidence and restoring real estate recovery. They’ve been announcing these since May. A lot is targeted toward reducing mortgage costs, first-home-buyer restrictions, and access to funding. They’re basically buying up excess stock to use as government-subsidized housing for the future. I don’t know if you’re familiar with Singapore’s Housing & Development Board, which builds subsidized housing that it sells to young couples buying their first homes. It’s based on means. The kickoff in China has been very slow. There was a bottleneck in the funding. There were implementation issues: How do you negotiate asset pricing with the real estate companies? Then the central government was not particularly guaranteeing anything to the local governments. All those things had to be fine-tuned. So, it’s been too early to see. But I think you are just starting to see that [real estate] absorption level rise, see more proactive purchases and pricing. The risk will be guaranteed by the People’s Bank of China and the central government. So, we’re expecting those benefits to flow through.
Norton: What sectors in China look best?
Tan: From a bottom-up basis, the huge discounts are on both consumer defensives and consumer cyclicals as well as the communication-services side. These three segments are the cheapest at the moment. There are some good quality companies in there, including some of our top picks like Tencent 00700 and Yum China YUMC. We also think this is an opportunity to pick up mainland listed (A-shares) China baijiu companies Kweichow Moutai 600519 and Luzhou Laojiao 000568. Those are wide-moat names on our top picks lists.
Norton: Let’s talk about the incoming Trump administration’s tariffs. What do they mean for China and Japan?
Wang: We don’t really know what will be in place, and what’s verbal saber-rattling. I think you’d want to stay positioned in sectors that are self-sufficient within China. These are services sectors, consumer staples that don’t rely on exports or manufacturing. So, look at names at a discount to fair value, that don’t have a lot of exposure to US exports, that don’t rely on supply chains for the US, that fit in the consumer staples/consumer discretionary categories.
Norton: How about in Japan?
Tan: For Japan, if we’re looking at cyclical recovery in China in 2025, then we’re looking at the factory automation space. These are global leaders and should benefit as China’s GDP growth bottoms and starts recovering. For this, we like wide-moat names like Fanuc, Harmonic Drive, and Yaskawa Electric 6506. Also, we like financials, particularly Japanese banks, such as Sumitomo Mitsui Financial 8316, because we expect ROE to expand over the long term. We also like some names with particular drivers, like Sony SONY. I don’t actually think tariffs would necessarily impact Sony, which is quite diversified. It’s unpredictable, but I think tariffs will not be imposed on more low-end consumer electronics.
Norton: What would you avoid in Asia for 2025?
Tan: If we look at which sectors are more expensive at this stage, it’s probably utilities and some of the industrials. You have to be very selective when it comes to those particular segments. Industrials is a very broad sector, but some subindustries have gone up a fair bit. Aerospace is slightly rich, but Asia as a whole is still relatively attractive compared with the US.
Wang: I’d avoid anything that tends to have higher volatility and headline risk.
Norton: Which will do better in 2025, China or Japan?
Tan: From a valuation perspective, I would say China, but there’s going to be a lot more volatility.
Wang: Higher upside, higher risk.
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