Rise of Asian Markets

Ichiro Suzuki

The Asian ‘emerging’ markets are on a tear lately. They are neither China nor India. Instead, they are South Korea and Taiwan. These two countries are still categorized as emerging markets in spite of per capita income that has surpassed Japan. Their currency control confines them in the EM ranks. It’s the policy of index compilers, most notably Morgan Stanley Capital International. Free flow of capital matters, since it ensures exiting out of the country any time investors wish. Investors would have to worry about this especially on China. Some American venture capital funds have been trapped there for some time, not being able to take profits on their investments and leave China. Malaysia used to belong to the developed world. In the middle of the Asian Financial Crisis in 1997, the Malaysian government had deployed capital control. MSCI responded to the action immediately, demoting the country to the emerging market ranks. 

Almost 30 years after the AFC, no Asian emerging country has been promoted to the developed world status. Israel is the only country to have been upgraded since then. Free-floating of currency is a big deal. China in particular has no interest in getting its renminbi off the control. One lesson that China has learned from Japan’s experience over the last half century was the damages caused by sharp appreciation of currency that was left to the mercy of the market. They don’t want to repeat a boom and bust nightmare that Japan had suffered, especially after the 1985 Plaza Accord that had engineered the yen’s super normal surge and a massive asset bubble produced by it. China wants to have none of this disaster though the country still suffered a sharp rise and fall in its real estate market without sharp currency appreciation. This determination leaves the country in the emerging market category almost indefinitely, unless MSCI changes its policy. 

On top of the RMB, China’s equity market is considerably bloated by stakes owned by the government. Beijing has always had strong grip in ownership structure especially among state-owned enterprises and their weight in the market has been going up since Xi Jinping rose to the helm of the Communist Party in the early 2010s. In index compilation, MSCI considers only free-float shares, excluding shares owned by the government, strategic owners, insiders and other restricted shares. In addition, there is foreign ownership limit that is 30% on any single company, and a single foreign investor can own only 10% of a company at most. After these adjustments, MSCI gives $2.7 trillion to the Chinese market including Hong Kong-listed H shares. The most extreme case on this adjustment is Saudi Arabia. Energy giant Saudi Aramco boasts of almost $2 trillion market capitalization but only 2% of its shares are traded publicly with the rest in the hands of the Kingdom’s government. China or Saudi Arabia, their market capitalization on the surface far exceeds what global investors are able to invest in. The Chinese market is doing all right recently amid resilience in the global market. It is, however, far from booming on the back of corporate earnings that in aggregate suffered three consecutive years of decline. This can happen only in China where rewarding shareholders is often taken so lightly, relegated to a secondary concern after sales growth and keeping vast production capacity in tact. Fierce competition in the domestic market and its adverse effect on profits can stay as a way of life in China’s corporate world even if the government has recently realized that they had better do something about it. 

South Korea and Taiwan, however, present entirely different stories. Both countries are on surging driven by the semiconductor sector that is going through an unprecedented upswing in chip demand due to AI-related investments. American Big Techs alone are making investments that are comparable to building railway networks across the country in the 19th century. AI has forced them radical shift in how Big Techs are run. Having been proud of asset light strategy that has enabled them to generate huge return on assets, they have realized that physical assets are critical in the AI race. To be specific, they can’t compete without data centers of their own that give them computing power. Mushroomed demand for chips had let the share prices of Taiwan Semiconductor (TSMC), Samsung Electronics and SK Hynix soar. Samsung has tripled over the last twelve months in its share price and hence market capitalization while TSMC has doubled. As a result, market capitalization of South Korea has overtaken a number of heavy weights in Europe, including France, Germany and the United Kingdom. Taiwan isn’t far behind South Korea. AI investments rule the world of equity investments in the mid-2020s. Weak presence in the sector has relegated Europe to the second division. On the other hand, Japan appears to be a little harder to catch for South Korea and Taiwan, at least for now. Japan is down from once the dominant position in chip making but isn’t out. While Japanese chip makers suffered a spectacular fall since the 1990s, chip-making equipment and material makers still maintain indispensable positions in the semiconductors’ global supply chain. NAND flash memory chip maker Kioxia is booming after its IPO last year, detached from the long-troubled Toshiba Corp. All together, Japan’s semiconductor industry is valued at approximately a trillion dollars. This size isn’t insignificant. 

These companies are leaders in its field of technology, well managed and immensely profitable. On top of it, the government has no stake in them. It is estimated that 82 to 84% of Samsung is free-float. The Lee family owns 5%+ directly and indirectly while other insiders own another 10%. These numbers are not much worse than the S&P500 whose free-float is estimated between 80 and 90%. TSMC is 93% free-float. Only foreign exchange control, though not as strict as China’s, is keeping these countries in the EM index, thus limiting opportunities to investors who follow the MSCI All countries index since it gives emerging markets only a 10% weight or a little higher. 

More active investors would choose to invest in these Asian semiconductor behemoths regardless of what the benchmark says. A pure stock picking decision could allow some investors to invest in them as “can’t miss” opportunities. Ballooning of South Korea and Taiwan have greatly more to do with the global AI investment boom than macro economic fundamentals of these two countries. If allowed to invest, some may choose to have a position in them.  

South Korea and Taiwan’s future trajectory is one question investors might have to consider while semiconductors are likely to remain critical components in the tech industry. The surge in demand today may or may not be a bubble. Even if this boom doesn’t prove to be a bubble, it is unthinkable that the current growth rate remains unabated in the medium term. Lower growth rates will definitely be seen sometime in the distant future, and the sector has been notoriously cyclical. Then, the market will assign lower valuation to these companies, exerting sharp downward pressure on their share prices. Samsung definitely will not triple every twelve months. Perhaps when this AI frenzy fades, the out-of-fashion European markets may be given a new lease on life. But for now, East Asia leads the world.

About the author: Mr. Suzuki is a retired banker based in Tokyo, Japan.