Asian technology stocks have surged dramatically in the first half of the year, raising the critical question: can this rally continue into the second half?
The MSCI Asia Pacific ex-Japan Index (MXAPJ) rose 21% in the first half, marking its fourth-strongest first-half performance in its 39-year history and its third-strongest second quarter. However, this was not a broad regional advance. South Korea surged 119% and Taiwan rose 56%, while the rest of the regional markets collectively fell 9%. Technology hardware was the strongest sector, gaining 91%.
Goldman Sachs analysts, including Timothy Moe, released an Asian equity strategy report, stating, "Earnings are the key driver for markets, hence we prefer markets and themes with the best growth." In other words, the strategy is not to seek out markets that haven't risen but to remain invested in areas with the strongest earnings growth, earnings revisions, and thematic momentum.
This framework sets a 12-month target of 1080 for the MXAPJ, implying a 23% price return and 25% total return in US dollar terms, with an expected return of over ten percentage points for the second half. The market strategy involves an overweight position on South Korea, Taiwan, Japan, and China A-shares, and an underweight on Australia and some ASEAN markets. Sector-wise, the preference is for technology hardware, capital goods, and the recently upgraded banking sector.
Concentrated Rally in North Asia and Tech
The first-half gains were not broad-based across Asia but were driven primarily by South Korea, Taiwan, and the technology hardware sector. While the MXAPJ rose 21%, excluding South Korea and Taiwan, the regional index actually fell 9%.
The technology hardware sector, up 91%, was the key driver, also explaining the significant outperformance of the South Korean and Taiwanese markets. Japan exhibited a similar pattern, with the Topix rising 16% and the more tech-heavy Nikkei 225 surging 38%, its third-strongest first half on record and best-ever second quarter, largely due to its higher weighting in information technology.
Macro Shift from Energy Shock to 'Reflation'
The macro environment for Asian equities has shifted from the energy supply shock earlier in the year back towards a 'reflationary' mix. Following the easing of tensions, oil prices have retreated significantly. As most Asian economies are net energy importers, lower oil prices alleviate both growth and inflationary pressures.
The global growth path also supports equities, with real global GDP growth expected to re-accelerate in the second half. Monetary policy is not uniformly accommodative, with some Asian central banks having tightened or likely to do so moderately due to currency pressures and stronger inflation. While the US dollar may remain strong near-term, a modest weakening is anticipated over a 12-month horizon, with many Asian currencies seen as undervalued.
Staying with Winners: The Earnings Gap is Key
The decision not to rotate into lagging assets hinges on the substantial earnings gap. The MXAPJ's expected EPS growth for 2026 and 2027 is 60% and 22%, respectively. South Korea and Taiwan are particularly standout, with 2026 EPS growth forecasts of 320% and 48%. In contrast, ASEAN markets and Australia are expected to deliver only mid-single-digit earnings growth.
The link between market performance and earnings has strengthened. Cross-sectional regression shows that nearly 80% of year-to-date regional performance can be explained by earnings growth or revisions. Historical samples also support the combination of a strong first half coupled with earnings upgrades, typically leading to better subsequent performance compared to rallies driven solely by valuation expansion.
AI Hardware as the Gateway to Broader Themes
The AI infrastructure hardware supply chain remains the core theme, driven by surging compute demand. This is creating record supply deficits in memory (DRAM and NAND), with price increases expected to significantly boost profits for memory makers and their supply chains.
The second layer is power demand, as AI compute expansion requires continuous investment in power generation and grids. Geopolitical events have further elevated policy focus on energy security and self-sufficiency.
This framework also incorporates the 'Heavy Asset, Low Obsolescence' (HALO) theme, covering hard-to-replicate physical assets like networks, infrastructure, and long-cycle industrial assets. These serve not only AI but also strategic capital expenditure areas like defense, power grid upgrades, and shipbuilding. Geopolitical tensions are driving spending in areas like US re-industrialization and defense.
Opportunities in China are seen as more tilted towards A-shares and thematic baskets. While offshore China has underperformed, A-shares, particularly the tech-heavy STAR 50 index, have been stronger. Focus areas include China's AI development, the 15th Five-Year Plan, shareholder returns, and a China growth basket. Emerging themes like the Asian space economy are also highlighted.
Maintaining Overweight on North Asia and Tech
Goldman Sachs' 12-month target path for the MXAPJ is 980, 1030, and 1080 points over 3, 6, and 12 months, respectively. The market strategy remains overweight South Korea, Taiwan, Japan, and China A-shares, while underweighting Australia, Thailand, Indonesia, and the Philippines.
Specific index targets include 12000 for the KOSPI (46% total USD return), 51000 for the Taiwan Weighted Index (18% return), 5500 for the CSI 300 (18% return), and 4400 for Japan's Topix (17% return).
Sector overweights are technology hardware & semiconductors, capital goods, healthcare, and banks (ex-Australia and China). Offshore China and India are key markets to watch for a potential turn more positive, contingent on an improvement in earnings prospects.
Primary Risks: Concentration and Crowding, Not Valuation
The main risks are not valuation but market concentration and crowding. First, market breadth is extremely narrow, with just eight stocks contributing 96% of the MXAPJ's year-to-date gains, meaning shifts in their earnings or valuation expectations are amplified across the entire index.
Second, retail speculation is heating up, notably in South Korea, where assets in leveraged ETFs on the index and single stocks have ballooned. The mechanics of these ETFs can create pro-cyclical rebalancing flows that exacerbate market moves.
Third, while optimism in tech hardware is high, valuations relative to growth (PEG) appear broadly reasonable historically. The differentiation lies within sub-sectors, with the market recently favoring those with lower PEG ratios. Fourth, primary market supply, especially if concentrated, could pressure secondary markets, with upcoming lock-up expiries posing a potential overhang later this year and in 2027.
Catalysts for the Second Half
The first set of catalysts are earnings, with the Q2 Asia Pacific reporting season in July-August being a key test for whether earnings upgrades can continue.
The second set involves central bank meetings, including the US Federal Reserve and the Bank of Japan, along with the Jackson Hole symposium.
The third set pertains to geopolitical developments. The fourth set includes elections, notably the US mid-term elections in November. The fifth set involves capital market activities, such as the pace of primary issuance and the timing of share lock-up expirations, which could impact secondary market performance.
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