Equities in emerging markets and Asia had a strong, albeit, volatile second quarter. The asset class returned more than 20%, outperforming both the U.S. and Europe, led by significant gains in the South Korean and Taiwan equity markets. However, there were a number of pullbacks in the markets triggered by concerns over the Iran conflict and the sustainability of the global artificial intelligence (AI) boom, which has supported chip manufacturers in Asia and big tech companies in the U.S. Volatility increased toward the end of the quarter, particularly in South Korea, Japan and China, where positive sentiment had intensified behind the AI trade.
Over the period, market performance reflected three key trends that gained momentum at the start of the year. First, the AI CapEx theme strengthened as large U.S. technology companies continued to spend on advanced semiconductors and memory chips to support the increase in compute and power capacity needed to meet the exploding demand for AI services. The technology and export-focused markets of South Korea and Taiwan continued to be the main beneficiaries of the theme.
The second trend was the ongoing reindustrialization narrative as developed economies continued to invest in defense capabilities, modernize their domestic industries and update their power infrastructure. This theme was notably beneficial for advanced manufacturing segments in South Korea and Japan. The third driver, which gained momentum in late 2025, was strength in commodities markets, supported by increasing global demand for electrification, power, renewable energy and AI infrastructure.
As the quarter progressed and the Iran conflict became more entrenched, the AI trade became the standout driver of returns in markets globally and a counter to investor anxiety over high energy prices. In June, easing concerns over the conflict and lower oil prices supported gains in other markets dependent on oil imports, including India.
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Key Markets:
South Korea and Taiwan
Market returns in South Korea and Taiwan were predominantly supported by earnings growth and positive sentiment generated from the vast spending by U.S. hyperscalers on components and materials used in AI infrastructure. In memory chips, where South Korean companies are global leaders, strong demand contributed to tight supply chains and a rapid increase in prices.
Both markets continued to leverage their areas of specialization. In Taiwan, market performance was underpinned by the gains of a small number of large chip foundries. These companies are shoring up their moats by expanding beyond core processors into other critical AI components including high-end multi-layer ceramic capacitors (MLCCs), printed circuit boards (PCB) and specialist chips like application-specific integrated circuits (ASIC).
South Korea’s economy is typically more diversified. In industries such as nuclear, defense, and shipbuilding, Korean companies can deliver high-specification products at scale and within short timelines. Despite this breadth, market performance in the quarter, which generated a return of 88%, was driven by two globally dominant memory chipmakers. Exuberance in the market over these companies was exacerbated by inflows and outflows tied to domestic retail investors holding leveraged, single-stock exchange traded funds (ETFs). We navigated this environment by focusing on the business models of companies. Ultimately, our positioning rests on earnings and valuations, while actively rotating exposures to maintain a diversified portfolio within the areas of innovation and technology.
China
China’s market declined by 6.6% in the quarter, a second consecutive quarterly decline. The economy performed relatively well over the period, supported by the country’s export industries. China continues to manufacture and sell at scale in industrials, materials, autos—particularly electric vehicles (EVs)—and electronics, to other emerging economies as well as Europe and the U.S.
However, China’s overall equity market is driven more by the dynamics of its domestic economy and here it is a very different story: consumer confidence and spending are weak, the labor market is not expanding and the property sector remains in the doldrums and in some areas is worsening. This environment is a negative for both consumer staples and consumer discretionary sectors and also for the revenues of large e-commerce operators and multi-platform internet companies.
The select areas of China’s domestic economy that are thriving are AI and technology, power infrastructure and energy generation. These businesses are rapidly expanding, serving other Asia markets as well as the domestic economy, and the segment has the explicit support of the Chinese government. We are beginning to see the hyperscaler phenomenon similar to the U.S. but on a smaller scale. We view this as a positive, structural, long-term theme and an area where pure-play China internet strategies and broader, passive index strategies aren’t exposed in the early phase. However, it remains a narrow pocket of China’s equity market.
Japan
For much of the quarter, Japan’s equity market generated robust returns. Corporate earnings were resilient, while overseas investor inflows were supported by a wider reallocation to Asia markets offering broad diversification and multiple sources of returns, including dividends and stock buybacks.
While Japan doesn’t have the same earnings growth outlook as South Korea and Taiwan, its offers potentially good prospects in similar export themes from AI-related hardware and industrial robotics to specialty chemicals, pharmaceuticals and power infrastructure. Its domestic economy is also a much bigger opportunity set than Korea’s and Taiwan’s and the environment is benefiting from some inflationary growth. The Takaichi government has an investment agenda with a large focus on AI and technology, and this should also support demand in the economy. Additionally, improvements in corporate governance in Japan are continuing and that is sustaining increased dividends and buybacks, contributing to Japan’s appeal as a destination for total return strategies.
Toward the end of the quarter, areas of the market that benefited directly and indirectly from favorable global AI sentiment experienced a pullback, reinforcing the importance to stay focused on the fundamentals of stock selection. While Japanese valuations are expensive relative to historic averages, it is important to be cognizant of thematic growth opportunities, the diversity of Japan’s domestic economy and continued progress in corporate capital efficiency.
India
India was a key country market in the asset class that benefited from the decline in oil prices toward the end of the quarter. In recent months, elevated energy costs resulting from the Iran conflict have been a major overhang on the market given India’s status as a significant oil importer. The easing tensions in the Middle East in June helped Indian equities generate a quarterly return of 10%—a contrast to the double-digit decline posted in the previous quarter.
However, we remain mindful of several challenges facing the economy and market. One of the legacy strengths of India’s economy has been in software, supported by well-educated and skilled engineers that successfully attracted U.S. and international companies to outsource to India. This moat is now being disrupted by AI. The Modi government’s investment agenda in domestic manufacturing also remains a work-in-progress. India is still buying significant amounts of goods from China because it can't produce them as cheaply itself.
The challenge for India, in our view, is that it must work to regain global competitive advantage in some of its key sectors. In addition, while earnings have been downgraded and there has been significant outflows from overseas investors, current valuations leave Indian equities relatively expensive compared with peers. We don’t believe there are structural flaws in Indian’s economy, but in the absence of a catalyst, be it thematic or at the macro level, the market overall is lacking the growth trajectory of recent years.
Latin America
The Latin American equity market posted a decline of about 4% during the quarter. While markets, particularly Brazil, had been supported by an easing global monetary environment in the latter months of 2025, macroeconomic conditions have become increasingly adverse this year as the prospect of sustainable interest rate cuts faded with the onset and entrenchment of the U.S.-Iran war.
In our view, the region offers some high-quality companies but performance is driven more by the top-down environment, domestic politics and the macro landscape. In Brazil’s case, the market is primarily focused on elevated interest rates and the uncertainty over whether a right-leaning government will return to power in October’s general election.
Southeast Asia and EMEA
Southeast Asia and Europe, Middle East and Africa (EMEA) remained peripheral to our approach in the quarter as they generally faced headwinds from high energy prices and, in parts of Southeast Asia, from domestic political tensions. Most notably, Indonesia fell by 26% on concerns over the interventionist policies of the Prabowo government that reflect an agenda of economic nationalism. Malaysia also declined on worries over higher energy prices and technology sector volatility. By contrast, Singapore, Vietnam and the Philippines posted gains. In the Philippines, sentiment improved toward the end of the quarter as oil prices receded following a period in which higher costs had weighed on the market.
In the Middle East, we continue to see attractive long-term structural opportunities in Saudia Arabia and the United Arab Emirates (UAE). However, in the near term, overseas business interest and tourism have been set back by the Iran conflict.
Outlook
We believe the outlook for the second half of the year from an economic perspective is reasonably robust. Growth in the U.S. economy may surprise on the upside likely due to resilience in consumer spending and the labor market. If political risk in the Middle East subsides this will be an additional positive. While it is unlikely in our view that a cycle of interest rate cuts will begin in the balance of this year, we anticipate it to be a period of strong growth which could be a tailwind for emerging markets.
We expect the global reindustrialization theme to continue, in part supported by a strong U.S. economy and a new era of geopolitics in which governments are placing a high priority on defense and the sustainability of their domestic economies. We also see expansion in AI, power and renewable energy infrastructure staying strong; however, we don’t think these themes are necessarily structural or cyclical. Overall, fundamentals appear strong across Asia and emerging markets and we anticipate improved earnings growth over the next few quarters. There could be further corrections but in our view this may be healthy for markets, offering windows for investors to add exposure.
Sean Taylor
Chief Investment Officer
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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