While Asian markets had a strong performance in the second quarter, it was only due to material outperformance by semiconductors, related equipment manufacturers, and supply chain entities on AI excitement. Excluding this, market returns were pedestrian, particularly after considering the rebound from Iran war lows, with healthcare posting a notable decline.
Looking ahead, we think the broad Hong Kong/China market remains attractive, trading at a discount to our fair value estimates, while Japan is fairly valued. However, there remain buying opportunities, with the percentage of buy calls in our coverage list staying roughly the same as in the first quarter.
The Asian Equity Market Is Up, but Only Technology Is Outperforming
The broad Asian market gained around 32% in the second quarter as Iran war risks abated and positive outlooks for artificial intelligence spending drove exceptional gains for the technology sector. Asian tech companies gained almost 93% in the quarter.
Other sectors saw more pedestrian returns. The consumer defensive sector continued to fall on Iran war risks for input costs, while the pullback in healthcare may reflect profit-taking after strong gains in 2025.
The technology sector is now about 30% of the broad Asian market, up from 19% at the end of 2025. It has overtaken financials as the most sizable sector by market cap. As a result, around half the broad Asian market is now represented by technology and financials.
We also saw decent gains in financials and industrials. Financials benefit from benign margin conditions, and industrials from AI-related investment. The gain in the communication services sector was largely due to one stock: Softbank SFTBY.
Buying Opportunities Are Deepest in the Communication Services, Consumer, and Healthcare Sectors
Of our China/Hong Kong coverage, 78%, inclusive of dual listings, are now in 4- or 5-star territory, up from 62% in the first quarter. Further falls in the share prices of e-commerce, travel, consumer defensive, and healthcare companies have increased outperformance ratings in our China coverage. The undervalued names in our technology coverage are mainly solar-panel-related entities, where excess capacity remains a near-term risk.
Japan’s solid gains were also led by the tech sector, but positive returns were more broad-based.
The technology sector’s strong rebound from the pullback in the March quarter has moved it from a 14% discount to our intrinsic value to being overvalued by 24%. We would prefer to see around a 20%-30% correction in technology share prices before we consider buying. Notably, the defensive sectors have gotten cheaper. In particular, healthcare is seeing a steeper 20% average discount to our fair values, up from 4%.
This is due to unique factors among the stocks we cover, which resulted in mixed March-quarter earnings performances and outlooks. However, we think that negative news is reflected and valuations are attractive. Inflation presents a risk to consumer companies, with domestic sales facing pressure. The downtrading trend to more mass products from the premium end may continue to hurt margins, especially with input costs staying firm.
Despite the broad Japan market gaining 23% in the second quarter, the percentage of 4- and 5-star-rated companies in our Japanese coverage is largely stable at 38%. Positive earnings guidance following the March-quarter results has led to raised valuations, and we still see buying opportunities across most sectors. The weakness in the Japanese yen is anticipated to provide some support to the exporters.
Sector Outlooks
Cyclical Sectors
Our select stock picks present a mix of companies we see as plainly undervalued against midcycle projections when spending patterns and demand normalize. Notably, we expect excess capacity and exceptional competition for some industries in China to abate, allowing for margin improvements over the next five years. We see more immediate upside potential for the financials and REITs, given our view for interest rates to be favorable.
Economically Sensitive Sectors
The technology sector’s stellar gains in the second quarter continue to leave us with limited buying opportunities. We still prefer the laggards, which include wide-moat leader Taiwan Semiconductor and Sino American Silicon 5483. Semiconductor equipment manufacturer Advantest 6857 is on the cusp of being an outperform call, and it will benefit from improved revenue visibility driven by AI-related spending. The internet and media companies on our list were sold down on AI disruption risks, which we think is overdone. High memory chip costs may also impede Nintendo’s fiscal earnings, but current discounts to the gaming companies’ intrinsic values are attractive.
Defensive Sectors
Consumer staples, especially brewers, were beaten down as growth rates slow. However, we think the slow growth is reflected, and the leading entities, which have strong brands, can maintain or even expand their market shares on industry consolidation and a consumption swing back to premium products. The second-quarter underperformance for healthcare names and the recent pullback in China utilities, largely unwarranted, leads us to add Innovent Biologics 01801, Hoya 7741, and China Longyuan Power Group 00916.
