Since mid-February 2016, when a vicious rout in global equity markets eventually came to a halt, stocks in emerging Asia have outperformed those in the rest of the world by a wide margin (see figure 1). Why?
To answer this question we first try to learn more about the index composition. So we break down the index constituents by both country and sector and single out the top 5 holdings. On a country level, it turns out that equity markets in emerging Asia are currently dominated by Chinese and Korean firms which jointly account for more than half the entire market capitalization (see figure 2). It is therefore no surprise that the Hang Seng and Kospi stock market indices are highly correlated with the MSCI Emerging Markets Asia index (see figure 3). However, despite their large weight both fail to outperform the regional index. How is this possible?
The sector breakdown eventually helps to solve the puzzle. In fact, the information technology sector (35.3%) and financial institutions (21.4%) make up the vast majority of market capitalization (see figure 4). Moreover, the top 5 index holdings (21.2%) are all part of the IT universe (see figure 5) and also roughly match the entire financials subindex in size. Finally, everything falls in place when considering that IT companies have largely outperformed financial institutions since the beginning of this year (see figure 6). A few Asian tech giants make up for most of the positive evolution of equity markets in emerging Asia.
What does this mean for investors? First of and foremost, the growth of IT companies has become the most important factor for emerging Asian markets. If IT firms do well, so do equity markets. On the downside, diversification in emerging Asia seems rather low. Second, in order to detect new growth potential investors might look at how well IT companies are represented in other major global indices (see figure 7). As turns out, in the US and India fast-growing IT companies represent roughly one fifth (21.0% and 17.1%, respectively) of the index capitalization compared to less than 10% in Brazil, Europe or Russia. Thus, investors may consider to shift some of their funds towards the US, India or emerging Asia to benefit from the growth potential the IT sector offers.
In conclusion, the recent strong outperformance of equity markets in emerging Asia can be traced back to a pre-dominant and dynamically evolving IT sector across emerging Asia. For investors, this implies that ignoring the region may mean to miss out a relevant growth story: Information technology. Hence, they may think about reallocating funds towards technology-rich equity markets in the US, India or emerging Asia.
Figure 1: Evolution of the MSCI All Country index vs. the MSCI Emerging Markets Asia index
Figure 2: Breakdown of the MSCI Emerging Markets Asia index by country
Figure 3: Evolution of the MSCI Emerging Markets Asia index vs. the Hang Seng (Hong Kong) and Kospi (Korea) indices
Figure 4: Breakdown of the MSCI Emerging Markets Asia index by sector
Figure 5: Top 5 Holdings of the MSCI Emerging Markets Asia index
Figure 6: Evolution of the MSCI Emerging Markets Asia vs. the technology and financials sectors of the MSCI All Country Asia ex JPN
Figure 7: Technology as a percentage of stock market capitalization by country
Published on Riskelia’s Blog