North Asian Stocks Come Up Short; Expectations Stocks in China, South Korea and Japan Would Rally in 2014 Have Failed to Bear Fruit

North Asian Stocks Come Up Short

Expectations Stocks in China, South Korea and Japan Would Rally in 2014 Have Failed to Bear Fruit

MIA LAMAR

May 30, 2014 12:47 a.m. ET

Five months into the year, widespread expectations that stocks in China, South Korea and Japan would rally in 2014 have failed to bear fruit, frustrating those betting North Asia would lead gains in the region.

In Tokyo, the Nikkei 225 index is down 10%, making it one of the world’s worst-performing stock markets after a year when it was one of the best. Chinese stocks listed in Hong Kong—the traditional route for foreign investors betting on China—are down 5.8% while equities in Korea are flat for the year.

The selloff comes as both China and Japan, Asia’s two biggest economies, have seen investor ebullience fade over their ambitious reform programs. China’s early efforts, such as cutting industrial capacity, has shown clear signs of weighing on economic growth, damping the appeal of a country also working to clean up years of runaway lending.

“There are big issues in China,” said Joshua Cragg, an Asian fundamental equities portfolio manager for BlackRock Inc. BLK -0.27% “It’s very difficult to put a price on it.” That uncertainty is deterring investors from what otherwise looks like a cheap market, he said.

By contrast, South Asian markets like Indonesia and India that were out of favor at the start of the year have rebounded sharply, bolstered by elections and investors returning to higher-yield emerging markets as U.S. bond yields remain low. The yield on the U.S. 10-year Treasury TWE.AU +0.97% note has bucked expectations and remained well below 3% for much of this year, yielding around 2.43% late Thursday.

The slide in Chinese stocks in particular has surprised many strategists who told clients at the end of last year to load up on their investments in the country following the end of China’s reform-minded plenary meeting.

Goldman Sachs Group Inc. GS -0.95% in late November upgraded China to overweight, saying North Asia was a preferred investment area for 2014 and that it expected China’s reform push to reinvigorate the market. The bank said then it expected the Hang Seng 0011.HK +0.31% China Enterprises CSHEF +2.78%Index to rise 20% by the end of 2014, hitting 13,600. The bank has since softened that call, although says it still largely prefers North Asia. The HSCEI closed Thursday at 10,185.21.

Others aren’t as optimistic. UBS AG UBSN.VX -1.64% in November also upgraded Chinese stocks to overweight in the wake of the country’s plenary meeting. Strategists remain upbeat on North Asian stocks—in particular Japan—but this month cut China to neutral as concerns build around the country’s slowing property sector.

“Investor conviction on China is very low,” said Tim Franks, head of hedge fund sales for HSBC Holdings HSBA.LN +0.16% in Hong Kong. “They don’t have any clarity and they just can’t quite get themselves to buy it yet.” HSBC had a bearish call on Chinese stocks until April, when it upgraded China and downgraded Malaysia and the Philippines, saying “the wide divergence in Asian equity market performance in 1Q cannot continue.”

There have been some bright spots. Taiwan, which Goldman Sachs upgraded in addition to China in November, has done better than its northern peers with the Taiex index currently at a more than three-year high. Stocks linked to the global technology supply chain have rallied sharply, including Apple Inc. AAPL +1.20% suppliers Taiwan Semiconductor Manufacturing Co. 2330.TW -2.05% and Pegatron Corp.4938.TW -0.17% The two stocks are up 18% and 45%, respectively, this year.

Some investors also say the North Asia trade will pay off with time. Catherine Yeung, an investment director for equities at Fidelity Worldwide Investment, said the firm has reduced its China exposure since the start of the year although it continues to see opportunity in the cheaper markets of China and South Korea.

“You are seeing some very attractive multiples, especially versus Southeast Asia,” Ms. Yeung said. Thailand, where the SET index is trading at 17 times last year’s earnings, looks “very expensive,” she said. The Hang Seng China Enterprises Index is trading at six times earnings by comparison.

Until then, however, investors like Hong Kong hedge fund Central Asset Investments are keeping their focus on countries like India, where the fund is studying smaller-capitalization companies that could benefit from an increase in infrastructure spending after the election victory of the pro-business Bharatiya Janata Party in May.

China “has been more of a trading market for us,” said portfolio manager Armand Yeung. “Valuation is cheap but until they do some more dramatic reforms…there haven’t been a lot of changes.”