While Asia stocks entered a bull market in January, the benchmark index for the region has since fallen more than 5% from its peak.
The region's rally – supported by China's reopening – seems to have hit a wall, but economists say MSCI's broadest index of Asia-Pacific shares outside Japan has further room to run.
Nomura Asia-Pacific equity strategist Chetan Seth said the firm expects the index at 700-levels by the end of this year – that's 8% higher than current levels as of Wednesday.
"We think Asian stock valuations are still modest," Seth said, pointing out the region's forward price-to-earnings ratio of 12.9 despite the rally – versus the U.S. market valuation of 18.5.
Seth added that China's economic and earnings recovery would provide further support as well as a recovery in fundamentals for technology, memory chips and semiconductors by the second half of this year.
He said recent U.S. data show further uncertainties lie ahead for inflation and economic growth.
"In the near term, Asian stocks will unlikely like this uncertainty and thus we expect some near-term volatility until a trend in the data is formed again," he said.
I still expect the Asian stock markets will outperform their U.S. peers after a short-term correction on China's reopening in 2023.Tina TengCMC Markets
JPMorgan also anticipates the MSCI Asia-Pacific ex-Japan index will reach 700-levels this year.
"After this current period of consolidation, we anticipate the MXASJ to test our bullish target for 2023 in 2Q2023," said Wendy Liu, JPMorgan's chief Asia and China equity strategist.
"The MXASJ may fall [or] consolidate in 3Q on macro resilience concerns before recovering in late 2023 for a synchronized global growth recovery in 2024," Liu said.
Uncertainties ahead
Recession fears loom for the eurozone and the U.S. after global central banks aggressively hiked rates to tame inflation. Uncertainties surrounding China's shift away from its zero-Covid policy also continue to linger.
"These uncertainties are more likely to dent than to derail the structural positive forces we see in Asian economies," said Minyue Liu, BNP Paribas' investment specialist on Asian and global emerging market equities, adding that these factors will only contribute to volatility in the near term.
"Modest valuations, light investor positioning and good fundamentals are buffers that should help Asian stocks withstand near-term volatility," BNP's Liu said.
She added that domestic demand in the region will be the "driver of economic growth," and she expects trade volumes to recover with China's market reopening.
The China factor
China's policies will continue to be a key factor in driving further growth for Asia-Pacific stocks.
CMC Markets analyst Tina Teng said the latest declines in Asia-Pacific stocks may have been due to investors who were eager to tap into China's reopening.
"Asian market's pullback in February may have been caused by a technical correction after a multi-month rally as the markets have been overbought when China started its U-turn in the Covid-zero policy, which fueled the rebounding optimism before materially seeing a promising economic recovery of the country," she said.
"I still expect the Asian stock markets will outperform their U.S. peers after a short-term correction on China's reopening in 2023," she said.
Credit Suisse's chief investment officer John Woods said China's onshore investors may be the key factor to driving the rally further.
"One missing piece in the China equity rally so far has been the low participation by onshore investors, which we expect to reverse as data – and confidence – improves," he wrote in a note.
"We anticipate the macro momentum to extend well into Q2, which should give further legs to the rally in equities," he said.
Correction: This story has been updated to correct the spelling of Nomura strategist Chetan Seth's name.