As the Global Equities Rally Broadens, Small Markets Steal the Spotlight

After being overlooked by investors for much of this year, smaller equity markets are starting to gain traction. This trend is particularly visible in Asia, where countries like Thailand, Singapore, and New Zealand have emerged as top performers in September. Their benchmark indices have each risen by at least 3%, even as the MSCI Inc.'s global stock gauge has declined by about 1% after a four-month winning streak.

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The shift in investor focus is happening as major equity markets like the U.S., Japan, and India take a breather, and China continues to face a deepening slump. Many of the smaller Asian markets have limited exposure to the artificial intelligence sector, meaning their valuations remain relatively affordable. This factor, combined with the Federal Reserve's dovish pivot, has strengthened their currencies and given some central banks room to consider rate cuts, making these markets more appealing.

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"Some investors are seeking diversification away from larger, more volatile markets, leading to increased capital inflows into smaller ones," said Manish Bhargava, CEO of Straits Investment Management in Singapore. He explained that investors aim to mitigate risks tied to larger economies and tap into the growth potential of smaller markets.

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The outperformance of these smaller, previously overlooked markets in September is not just limited to Asia. Equity indices in countries like Argentina, Lebanon, and Zambia also rank among the top performers globally this month, according to data from more than 90 global gauges tracked by Bloomberg. In Asia specifically, foreign investors are on track for their fifth consecutive week of inflows into Southeast Asian stocks.

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Meanwhile, volatility has been increasing in the U.S. as traders grapple with the Federal Reserve's pace of easing, the upcoming U.S. election, and concerns over whether the AI boom has peaked. In Japan, the strength of the yen has stalled a record-breaking stock rally as the Bank of Japan prepares for another rate hike. India, too, is facing valuation worries after achieving impressive gains.

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In contrast, South Korea and Taiwan—both tech-heavy markets—have seen foreign outflows from stocks this month due to uncertainty surrounding the future of AI-related shares.

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Some smaller economies are benefitting from local developments, such as Thailand's return to political stability and Singapore's focus on Real Estate Investment Trusts (REITs), a sector that tends to thrive in environments with lower global interest rates. These positive local factors are attracting investors to these markets.

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Valuations are also in favor of these smaller markets, even after recent gains. Benchmarks for Thailand, Singapore, and the Philippines are trading at less than 15 times their 12-month forward earnings estimates, all below their three-year average ratios. This is in stark contrast to the MSCI global gauge, which has a multiple of over 17, and the S&P 500 and India's NSE Nifty 50, both of which have ratios exceeding 20.

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Some Asian economies have already started easing monetary policy ahead of the Federal Reserve, as a weakening dollar allows central banks to shift focus toward supporting economic growth. For instance, the Reserve Bank of New Zealand cut rates last month, earlier than many had anticipated. Expectations of further rate cuts have bolstered the country's equity benchmark. Similarly, the Philippines slashed rates for the first time in nearly four years and hinted at more easing in the future, while Indonesia and Thailand are expected to follow suit in the fourth quarter.

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"The hope is that with U.S. interest rate cuts and a dollar that is biased toward weakness, the smaller countries can act a bit independently on interest policy," said Gary Dugan, CEO of the Global CIO Office.

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However, the relatively small size of these markets and a limited pool of large-cap stocks could be a barrier for long-term investors like pension funds, potentially capping the level of foreign capital inflows. Additionally, this outperformance may prove to be short-lived if a resurgence in risk appetite rekindles the global interest in AI-driven investments.

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"This broadening rally signals a shift in investor sentiment," said James Cheo, Chief Investment Officer for Southeast Asia and India at HSBC Global Private Banking and Wealth. "As U.S. rates stabilize or decline, this provides room for smaller economies to adjust their own policies without the fear of significant capital outflows that were more prevalent during the Fed's tightening cycle."

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While smaller markets are enjoying a moment of increased investor attention, several factors could influence their future performance. The changing dynamics in global monetary policy and the evolving narrative around AI investments could either sustain or reverse the current trend. For now, smaller markets like those in Southeast Asia are capitalizing on their relatively low valuations, domestic economic stability, and the easing policies of their central banks.

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These markets offer a diversification opportunity for investors looking to reduce exposure to more volatile, larger economies. However, the long-term outlook depends on how global economic conditions, including U.S. monetary policy and the trajectory of AI-related industries, unfold. In the meantime, the shift in investor focus indicates a willingness to explore beyond traditional investment avenues, reflecting a nuanced approach to managing risk and capitalizing on growth potential in a changing global landscape.

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