Investors are getting bearish on China — but see other upside opportunities in Asia

Published Wed, Aug 30 20239:26 PM EDT

China's deteriorating economy is prompting fears of a global slowdown. However, some investors believe a bearish China story is shifting the spotlight onto investment opportunities in other Asian markets. Morgan Stanley downgraded the iShares MSCI China ETF (MCHI) to equal weight from overweight in early August, citing lower earnings growth expectations and structural challenges. The country's most recent economic data came in largely under expectations . "The rest of the world might not be overly concerned about the economic outlook for China if it were still a periphery economy. However, a meaningful economic downturn in the world's second largest economy could have significant implications for other economies," Wells Fargo chief economist Jay Bryson wrote in a recent note. Opportunity in Japan Japan currently stands out as a "particularly attractive" investment play, according to Horizon Investments chief investment officer Scott Ladner. The third-largest economy is now his biggest international weight in his portfolio as he shifts exposure away from China. "There's still quite a lot of stimulus in the pipeline in Japan. And it looks to us that that means that Japanese corporations may have a pretty material tailwind for earnings for the next six to 12 months," Ladner said. Morgan Stanley also has a bullish short- and medium-term outlook on Japan. "Frequently maligned as an 'old' economy, Japan is the fastest growing DM economy within our coverage and has become quite trendy," global chief economist Seth Carpenter wrote in a note dated June 26. Even with the Bank of Japan changing its policy on yield curve control, the tailwind for corporate earnings for Japanese equities is underappreciated, he added. Investors can get access to the Japanese market through the iShares MSCI Japan ETF (EWJ) , which has an expense ratio of 0.5% and more than $13 billion in assets. Although the ETF has posted a total return of -3.6% in August, it's up 13% year to date. The recent appreciation of the dollar against the yen may also make Japanese equities an appealing investment play. Other opportunities in Asia-Pacific In addition to Japan, South Korea and Taiwan are other Asian markets best positioned to withstand and overcome low growth in China, said Glovista Investments chief investment officer Carlos Asilis. Despite the three countries being top trading partners with China — and Korea and Taiwan begin notably export-reliant economies — Asilis believes the remaining northeast Asian countries will be unscathed. "Taiwan, South Korea and Japan are the least vulnerable, because they were the source of foreign direct investment, and their exposure through China was more in the capital account," Asilis said. Ways to play the space include the iShares MSCI South Korea ETF (EWY) , the Franklin FTSE South Korea ETF (FLKR) and the iShares MSCI Taiwan ETF (EWT) . The iShares South Korea and Taiwan ETFs each have expense ratios of 0.58%, while Franklin Templeton's FLKR weighs in at an expense ratio of 0.09%. To be sure, other markets in the Asia-Pacific region face downside risks from China's slowdown. Asilis highlighted Australia as the most heavily exposed economy due to its high commodities exports and infrastructure investment in China. "If you're in the Asian emerging universe, there's no way to be completely isolated from China," Ladner said. "But we've heard things about companies moving supply chains over to India, Vietnam, Indonesia [which] are competitive. China going down somewhat does benefit … those other regions that were just overlooked." The investor is optimistic on the semiconductor trade in the region, noting that Taiwan is already a preeminent player in the market. Japan and South Korea are also making efforts to ramp up semiconductor manufacturing. The countries may also benefit from the escalating rift between the U.S. and China that may shift global supply chains to their favor.