Morningstar, the rating agency, published its third-quarter outlook for Asian stock markets, noting that apart from utility stocks outperforming, performance across various sectors narrowed in the second quarter. Financial and telecommunications stocks showed some strength during the period due to positive first-quarter results. In addition to the above sectors, the agency is bullish on strong rebound in Chinese retail sales by 2025, and also sees potential in REITs and consumer defensive stocks, recommending seven stocks from cyclical industries, defensive industries, and economically sensitive stocks. Rate cut expectations benefit Asian utility stocks, REITs, and consumer defensive stocks Morningstar forecasts that performance in the third quarter of Asian stocks will show greater divergence due to second-quarter and first-half results, with weak consumer spending possibly causing some disappointments. The performance of the US stock market is still dominated by Nvidia (NVDA.US) and artificial intelligence (AI) stories, lacking widespread leadership. Therefore, it would not be surprising to see range-bound trading before the earnings season in July and August. Weakening inflation data and sluggish economic growth will prompt more central banks to take action, with the Fed possibly cutting rates in the second half of 2024. This could continue to support the performance of utility stocks and generate interest in real estate investment trusts (REITs) and consumer defensive investments. Asian stocks still significantly undervalued Morningstar's outlook points out that while the Morningstar Asia Market Index has been on an upward trend, its trading price is 13% below the agency's fair value estimate. China: Mixed performance in the second quarter, overall good performance, still with significant upside potential; Morningstar believes that favorable policy news remains the main positive driver for the Chinese stock market. Japan: Optimistic about its prospects; but after the announcement of the results for the March fiscal year, stock prices were mixed, signaling general caution, with selective buying opportunities for lagging stocks. Hong Kong A shares see recovery relying on two major catalysts Given geopolitical tensions, the agency continues to favor companies with good quality in China and focused on domestic operations, unchanged by the first-quarter operating data and results. Performance drivers will come from the recovery of Chinese consumption and Fed rate cuts. The latter has to some extent reflected in the exceptional performance of utility stocks so far this year, but other sectors such as REITs and consumer defensive stocks have not been considered as driving factors. China's consumer improvement depends on domestic real estate The agency believes that with stabilizing property prices and policy support starting to have a broader impact, Chinese consumption should begin to show a stronger recovery by 2025, with a preference for domestically superior consumer goods companies. Although stock prices have rebounded from their lows after the announcement of additional policy support, buying opportunities still exist for cyclical consumption and real estate industries led by Chinese companies. For the real estate sector, the agency believes that in the short term, further upward movement will require data reflecting a bottoming out of property prices and commercial real estate demand in mainland China and Hong Kong; without these conditions, only range-bound trading will be seen.