Asian equity markets may be entering a new phase of leadership rotation, according to a recent report. The previously narrow rally, led by the semiconductor sector, has stretched valuation gaps to their widest levels in nearly two decades.
As concerns mount over excessive valuations and the sustainability of the artificial intelligence investment boom, investors are beginning to withdraw from some of the region's top-performing markets this year, notably South Korea and Taiwan. While Asian stocks have collectively outperformed US equities by approximately 16% year-to-date, the gains have been highly concentrated. Robust semiconductor earnings and active participation from local retail investors have driven significant returns in South Korea and Taiwan.
Societe Generale's analysis suggests that excluding just three stocks—TSMC, Samsung Electronics, and SK Hynix—Asian equities would have actually underperformed their US counterparts so far this year. Recent market movements indicate this concentration may be starting to unravel. South Korea's main index has retreated more than 20% from its recent peak, technically entering its second bear market of the year. Meanwhile, India, after months of underperformance, has begun to outpace regional peers. Taiwan has also started outperforming Korea, and Japan's TOPIX index has strengthened relative to the tech-heavy Nikkei 225.
Foreign fund flows are reinforcing this trend. Although overseas investors remain net sellers of Asian stocks excluding Japan, capital has recently returned to India and other South Asian markets, while South Korea and Taiwan continue to experience outflows. The upcoming earnings season will be a critical test for determining whether market leadership can genuinely broaden.
The bank notes that valuation dispersion across Asian markets has reached extreme levels, making previously leading markets particularly vulnerable to any earnings disappointments. Investors would benefit if leadership expands from a few AI-related semiconductor stocks to markets and sectors with lower valuations, improving macroeconomic conditions, and more sustainable earnings growth.
The price-to-book valuation spread between Asian markets has climbed to its highest level since 2007—a period that also preceded a significant shift in market leadership. Historical patterns show that phases of declining market correlations and narrowing valuation gaps often signal a broader diffusion of participation across regional equities. Similar patterns emerged before major turning points in 2007, 2011, 2015-16, and 2021.
The current environment is seen as analogous to those periods, with cross-market correlations falling and investors increasingly questioning whether AI beneficiaries can continue to justify their lofty valuations. For specific trade ideas, Societe Generale recommends a relative value strategy of going long Taiwan and short South Korea.
While South Korea has benefited from soaring memory chip prices and a sharp earnings rebound, consensus forecasts point to a significant deceleration in profit growth over the next two years. In contrast, Taiwan's semiconductor sector, with its greater exposure to foundry and logic chips, is viewed as more resilient and is expected to deliver more stable earnings and profit margins.
The bank is also optimistic about the TOPIX index outperforming the Nikkei 225. Although the Nikkei 225 has been a primary beneficiary of the AI-related tech rally, earnings growth in Japan is anticipated to broaden into financial, industrial, automotive, and commodity-related sectors. Bank stocks, in particular, are seen as well-positioned to benefit from domestic inflation, the Bank of Japan's policy normalization, and accelerating loan growth.
Explaining the preference for Taiwan over Korea, the report stated, "At current valuation levels, the sustainability of earnings is more important than simply high growth." It noted that investors are increasingly placing a higher premium on earnings resilience rather than cyclical growth surges.
With valuation dispersion at a multi-decade high and signals of investor repositioning already evident, the probability of a continued rotation within Asian equities is seen as rising. However, the imminent earnings season will be pivotal in determining whether this rotation accelerates.
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