For a region whose success in keeping the Covid-19 pandemic at bay was one of the main reasons behind the outperformance of its stock markets in 2020, Asia has turned out to be a disappointment for global equity investors this year. While the MSCI All-Country World Index, a gauge of stocks in developed and developing economies, is up 11 per cent this year, the MSCI Asia Pacific Index has risen just 5 per cent. At one point last month, Asian shares briefly entered correction territory – a fall of 10 per cent or more from the most recent high – in a sign of the severity of the slump. The underperformance of Asian stocks is widely attributed to the surge in infections across the region. While India’s ferocious second wave is worse than the other major outbreaks the world has suffered, it is the sharp rise in cases in countries that were considered exemplars of effective containment, such as Taiwan and Singapore , that has knocked sentiment. What is particularly concerning about the multiple outbreaks across the region is that both high- and low-income countries are affected. Even in places with plenty of vaccines available, such as Hong Kong, complacency and misinformation are stymieing immunisation campaigns. Last month’s sharp sell-off in the Taiex, Taiwan’s benchmark stock index, was a reminder that insufficient testing capacity can compromise even the strictest containment measures. However, the dramatic increases in asset prices during the pandemic showed that infection rates were never the key determinant of sentiment. Other factors, notably the surge in global liquidity and the strength of the recovery, have had a much bigger impact. Just as the S&P 500 kept rising when the US was suffering a brutal third wave at the end of last year, the Nifty 50, India’s main equity gauge, hit a record high on Monday after rising nearly 9 per cent since April 12. Indian companies have raised US$4 billion via initial public offerings this year, the busiest first half of the year since 2017, according to Bloomberg. Furthermore, expectations are crucial. While investors were taken aback by the speed and vigour of China’s recovery last year, they have been pleasantly surprised by the ramp-up in vaccination programmes in Europe in recent months. The Euro Stoxx 50, the main gauge of shares in the euro zone, is up 14.5 per cent this year, outperforming the S&P 500. In a sign of the extent to which Europe has exceeded expectations, euro-zone stocks have overtaken their emerging-market peers in terms of global positioning, according to the findings of last month’s Bank of America fund manager survey. Asia’s underperformance is in part the flip side of Europe’s outperformance. What is more, 2020 is an inappropriate yardstick for measuring the performance of Asian markets and asset prices in general. While last year was the “everything rally”, with most assets enjoying exceptionally strong gains mainly because of unprecedented levels of stimulus, there is more uncertainty this year. The combination of fears about a sharp rise in inflation leading to an earlier-than-expected withdrawal of stimulus, severely stretched valuations and less conviction around technology stocks makes for a difficult trading environment. All three factors have contributed to the deterioration in sentiment towards Asia, where tech stocks have a large weighting in the regional index. Yet, while valuations remain above their long-term average, they are below their peak in January and much cheaper than in the US. Moreover, leading manufacturers in East Asia have the right product mix for the post-Covid-19 era. At a time when global supply chains are strained by shortages of semiconductors and other key components, the region’s chip makers – especially Taiwan’s TSMC and South Korea’s Samsung – are playing a crucial role in the global economy. Although sentiment has shifted towards industries that benefit most from the normalisation of economic activity, the global strategic position of East Asia’s chip makers and the appeal of digitalisation as a long-term secular trend bode well for Asian equities. Another reason to be sanguine about Asia is the increasing “domestication” of the region’s stock markets, with retail investors accounting for a high share of daily turnover in key markets. According to Bloomberg, individual investors are responsible for 70 to 75 per cent of transactions in South Korea and Taiwan, helping offset net selling by foreign investors. Increased participation by retail traders does increase volatility , partly because it is fuelled by a surge in margin debt. Yet, it is part of a healthy democratisation of trading which, in Asia’s case, also helps shore up stock markets at a time of mounting uncertainty. While the surge in infections across the region is cause for concern, there are good reasons for equity investors to remain upbeat on Asia. Nicholas Spiro is a partner at Lauressa Advisory