Asian equities may be relative winner in US recession: Raychaudhuri

May 1 – If a recession materialises in the United States this year, the relative performance of U.S. and Asian equities will likely be quite different from what investors have seen in past decades. Indeed, the latter may be the ‘risk-off’ trade this time around.

The U.S. economy contracted modestly in the first quarter, based on the initial estimate released on Wednesday. While that’s only one quarter of negative growth, there are other nascent signs that a U.S. recession could already have started.

Consumer confidence is plummeting. In April, The University of Michigan’s Consumer Sentiment Index touched the lowest point in the past 35 years, excluding the brief pandemic-related trough.

A second time-tested leading indicator of recession is the inversion and subsequent steepening of the Treasury yield curve. In the past 50 years, the difference between the U.S. 10-year and 2-year Treasury yields has almost always turned negative and then positive before a recession ensued. We’re seeing that play out now.

U.S. equities have suffered less than their Asian counterparts in all but one of the four recessions since Asian equity data became available in 1990. Again, the exception was the brief COVID-19 downturn. The deepest recession, which occurred during the 2008-09 Global Financial Crisis, saw the highest outperformance of the S&P 500 Index versus the MSCI Asia ex Japan Index, even though the epicentre of the crisis was in the U.S.

This behaviour is largely explained by the fact that recessions increase risk aversion among investors, causing funds to flow towards “safe haven” assets, which typically means moving away from emerging markets.

But things might be different this time around. Asia could outperform the U.S., whether the potential downturn is a true recession or a period of stagflation.

First, economic growth forecasts have been cut more sharply in the U.S. than in most of Asia, something that has not preceded most recent U.S. recessions. The International Monetary Fund cut its estimate for 2025 U.S. growth by 87 basis points, compared to an average of 67 for the six biggest Asian economies, excluding Japan.

The inflation outlook is also more benign in much of Asia. The IMF increased the median inflation forecast for the U.S. from 1.96% in its January outlook to 3.00% in April. Meanwhile, China is now expected to experience modest deflation, and the inflation forecast for emerging economies excluding China declined from 3.88% to 3.79%.

Importantly, the U.S. has almost no policy space to offset any growth slowdown.

On the monetary policy side, the Federal Reserve could face an environment of declining growth and rising inflation and thus will likely be wary of cutting interest rates too quickly. Fed Chair Jerome Powell recently highlighted the risk that tariff-driven increases in inflationary expectations could become persistent.

In contrast, many Asian central banks, especially in Indonesia, the Philippines and China, have significant policy space to cut interest rates, with prevailing real policy rates of 3.5-5.0%.

Fiscal expansion in the U.S. also seems unlikely, given that America’s public debt has risen to roughly 120% of GDP and its deficit has expanded to more than 6% of GDP.

The public debt situation is drastically different in Asia. Barring Japan and Singapore, all other Asian countries have lower public debt than the U.S. and hence greater fiscal policy space. In particular, the two largest economies – China and India – both have public debt to GDP ratios below 90%.

Finally, the most notable difference this time around is in equity valuations. Equity drawdowns during past recessions were largely driven by an overall reduction in valuations. Indeed, more than half of the Asian market’s declines in both 2001 and 2008-09 were caused by price-to-earnings multiples collapsing.

But equity valuations in Asia are already quite modest, both compared to where they were during previous U.S. recessions and relative to current U.S. valuations, so there is little room for significant declines. The MSCI Asia ex Japan index is trading at a PE multiple of around 12.5x compared to roughly 20x for the S&P 500, as of April 24. If valuation risk exists anywhere, it’s almost certainly in the U.S.

Markets currently seem to believe in Asian equities’ robustness relative to the U.S. While it’s still early days, the MSCI Asia ex Japan index has outperformed the S&P 500 handsomely this year.

And the two markets’ behaviour in the tumultuous month of April is even more telling. The Trump administration’s announcement of ‘reciprocal’ tariffs on April 2 crashed both markets by 10-12%. But the rollback of tariffs a week later led to a much steadier recovery in Asia than in the U.S., which is not overly surprising given that the source of volatility is American policymaking.

Risks for Asia, of course, can’t be wished away. China’s slowing economy needs policy support to neutralise the pressure the trade war will have on exports. And pockets of the region, including Korean and Taiwanese technology giants, remain heavily export dependent and thus will be seeking timely execution of bilateral trade agreements with the U.S.

But the alarm has been sounded, and it is unlikely that investors’ risk appetite will go back to its pre-April 2 levels anytime soon. What is striking, though, is that a ‘risk-off’ environment now could actually be positive for Asian equities – something we haven’t seen before.

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