A Solid Quarter Signals Promising Potential

Last quarter, the central bank cut interest rates twice and sectors that are rate sensitive such as banks and non-banking financials generated robust returns. We also saw signs of a pickup in rural growth and more demand for consumer discretionary goods. Conversely, information technology (IT), pharmaceuticals, manufacturing exporters and business segments more exposed to the dollar and the U.S. economy did less well.

North Asia

South Korea’s impressive gain of 34% in the second quarter were supported by multiple drivers. Following a challenging start to the year marked by economic growth concerns and domestic political turmoil, sentiment improved during the quarter as the country’s technology and AI-related industries sustained robust growth. Additionally, interest increased in other areas including heavy industry and shipping, partly on speculation over potential trade agreements with the U.S.

However, the most important catalyst, in our view, was the election of President Lee Jae Myung, who we think is a progressive and market friendly leader likely to push for change that will be positive for reforming chaebol holding companies, particular relating to inheritance tax.

Taiwan’s market also performed strongly and has been driven almost singularly by the AI theme. We employed a cautious approach during the quarter. While we would have preferred more exposure to the market, we think there is elevated risk due to rich valuations and significant dependence on the U.S. tech sector and market.

China

China’s market registered a 2.1% gain in the quarter³ amid a mixed performance that was held back by a tit-for-tat escalation of tariffs with the U.S. which raised concerns that an effective trade embargo would trigger a downward revision in earnings and disrupt economic growth. Sentiment improved after the two countries reached a trade framework in June to lift restrictions on critical rare earth magnets exports to the U.S. and certain chip technology to China.

Within China’s domestic economy, there were few signs of improvements, particularly in consumption and the property market. During the quarter, there were substantial south-bound flows from mainland investors into the Hong Kong equity market, which is more weighted to e-commerce, internet platforms and dividend paying-financial stocks. In certain segments of the offshore market, like electric vehicles (EVs), interest from international investors also increased.

In the period, as in the previous quarter, overall performance in the Chinese market was largely driven by a small handful of technology, communication services and consumer discretionary stocks. There have also been thematic opportunities, like biotech—which the market views as going through a “DeepSeek moment” in terms of product breakthroughs. Conversely, exposure to traditional consumer stocks was less as we have yet to see a pickup in the broader economy.

Japan

Japan’s market posted a strong performance in the quarter⁴. Investors were initially concerned about central bank monetary policy and potential for rate hikes later in the year while negative sentiment impacted exporters —especially in the auto sector—over U.S. tariff concerns. However, after the introduction and then pause of U.S. reciprocal tariffs, investor flows into Japan surged as interest in international markets grew amid questions over the strength of U.S. economic growth.

For the internal economy, there were several areas of robust performance including insurance. We have generally maintained our focus on searching for good earnings growth and cheap valuations, which continues to be a strength of the Japanese equity market. Additionally, capital efficiency reforms remain a key market attraction.

Southeast Asia and Latin America

A number of Association of Southeast Asian Nations (ASEAN) markets including Indonesia, the Philippines and Thailand were affected by domestic political uncertainty and the threat of double-digit tariffs on exports to the U.S. Singapore’s market gained thanks to total returns generated by financials and the performance of local stocks and companies exposed to the international economy.

Latin America outperformed the broad emerging markets index in the second quarter⁵. There is a strong belief in the market that inflation in Brazil is coming under control and that there may be significant cuts to interest rates over the next 18 months. While there have been concerns over fiscal spending, as we get closer to the 2026 election, there’s hope that there may be a change of government. Mexico’s markets did well because of its alignments to the U.S. economy and as concerns abated over tariffs, however, we believe economic growth is sub-par and needs a catalyst.

Europe, the Middle East and Africa [EMEA]

A major area of uncertainty during the quarter was the rapid escalation of the Israel-Iran conflict. It is clearly a fragile situation, and the trajectory of the conflict and tensions may or may not have significant implications for the wider region and global economy. In terms of protecting our emerging markets portfolios, we are focused on getting the right balance between dividends and growth as we diversify across markets, particularly ones focused on domestic demand. In the Gulf, Saudi Arabia and the United Arab Emirates (UAE) are changing and both nations have investment plans for broadening their economies, but they also need funding and the confidence of the world.

Outlook

These are uncertain times, with only days remaining until President Trump’s July 9 deadline for reaching agreements with U.S. trading partners before reciprocal tariffs resume. Some market volatility is to be expected. However, we believe the peak fear of tariffs has passed—unless the U.S. doubles down and ratchets up duties on countries where no agreements are reached. If deals are secured, they could serve as tailwinds, especially if tariffs on some nations are reduced. Another key aspect of tariffs is their potential impact on U.S. growth. At present, there is little evidence that tariffs have been hurting the consumer, corporate CapEx, earnings or economic growth but this could change going forward.

• We see opportunities in South Korea as the macro environment improves and a more progressive, market-friendly government establishes itself. Technology is still a key area and heavier industries are beginning to do well, and both may get support in potential trade deals with U.S. There are also attractive financials with compelling yields and the ‘value up’ governance reforms continue to progress.
• In Taiwan, we are avoiding stocks related to electronics and the U.S. consumer. We are mindful of the potential for slowing U.S. economic growth and its implication for Taiwan’s market and the economy. There remain significant opportunities in AI though valuations are elevated.
• The macro environment in Japan is hard to project so our approach is pivoted to generating alpha from stock selection. This means focusing on domestic total returns and company-specific idiosyncratic opportunities. The market also anticipates bilateral discussions with the U.S. to progress. Japan could be less exposed to U.S. tariffs given its history of direct investing in the U.S. and its ability to dampen its trade surplus with defense spending and other moves.
• In China, we are focusing on higher growth stocks with upward earnings revisions, as well as on more defensive areas with attractive dividend yields like financials. We are also giving consideration to thematics like AI and biotech. We’re not seeing a meaningful pickup in property and general consumption but we do think there may be some progress in these areas later in the year and into 2026. In addition, progress in trade negotiations with the U.S. could lift sentiment generally.
• India is a domestically-driven economy with robust structural drivers. The central bank’s rate cuts are positive and have supported gains in the market, however, it is unclear as to the degree to which they will boost economic growth and support an improvement in consumer spending. In addition, we remain concerned about elevated valuations and are focusing on the cheaper areas of the markets, particularly when we are looking at growth stocks.
• Latin America could potentially deliver positive performance over the next 18 months. In Brazil, valuations are compelling and the market is under-owned. Across the region, there are signs of domestic politics moving to the center or to the right which is encouraging for growth and the markets and supportive of equity risk premiums. This move, together with a potential loosening monetary environment and a weaker U.S. dollar, would be favorable for Latin American markets.

Summary

There was good performance across emerging markets in the past quarter. However, a large proportion of returns have been related to increasing valuations and currency movements and we're still to see improvements in the earnings growth working through, which could potentially offer significant upside pressure to investment returns.

Once we get through some of the summer headwinds, in terms of seasonality, the conflict in the Middle East, and there is more clarity on trade and tariffs and, perhaps most importantly, more clarity on the U.S. economy, we will have greater visibility on the prospects for global equity markets. We believe that could be the time for global allocators to add structurally to emerging markets as we think the drivers and strengths of the asset class—earnings recovery, diversification, more progressive governments, a weaker dollar, and cheap valuations—will start to gain traction.

Notes:
¹ MSCI Emerging Markets Index, MSCI Korea 25-50 Index, MSCI Taiwan Index
² MSCI India Index
³ MSCI China Index
⁴ MSCI Japan Index
⁵ MSCI Emerging Markets Latin America Index. As of June 30, 2025

Sean Taylor
Chief Investment Officer

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The views and information discussed in this report are as of the date of publication, are subject to change and may not reflect current views. The views expressed represent an assessment of market conditions at a specific point in time, are opinions only and should not be relied upon as investment advice regarding a particular investment or markets in general. Such information does not constitute a recommendation to buy or sell specific securities or investment vehicles. Investment involves risk. Investing in international and emerging markets may involve additional risks, such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation. Investing in small- and mid-size companies is more risky and volatile than investing in large companies as they may be more volatile and less liquid than larger companies. Past performance is no guarantee of future results. The information contained herein has been derived from sources believed to be reliable and accurate at the time of compilation, but no representation or warranty (express or implied) is made as to the accuracy or completeness of any of this information. Matthews Asia and its affiliates do not accept any liability for losses either direct or consequential caused by the use of this information.

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