Asian health-care companies and utilities will fail to repeat as the region's best-performing stocks this quarter if history is any guide.

The two industry groups, seen as ``defensive'' because of their ability to weather economic slumps, led the Morgan Stanley Capital International Asia-Pacific Index's 10 industry groups in the second quarter as rising interest rates fueled demand. The index, which slid last week, dropped the most in two years.

There were just three other times in the past decade when they set the pace: in 1998 during the Asian financial crisis, in 2001 when terrorists attacked the U.S., and in the 2002 buildup to war in Iraq. Each time, riskier bets had bigger payoffs in the following three months.

``I wouldn't be looking to be very defensive and buying stocks that are pure cashflow and without growth,'' said Mark Williams, who oversees the equivalent of $500 million in Asian stocks at F&C Asset Management Plc in London.

An index of the MSCI Asia-Pacific's health-care companies fell 0.4 percent last week, exceeding a 0.1 percent decline in the regional benchmark. Utilities gained 0.3 percent, based on the performance of their index.

The health-care and utility gauges climbed 4.4 percent and 1.9 percent, respectively, during the second quarter as the Asia-Pacific index slid 3.1 percent. Takeda Pharmaceutical Co., Japan's largest drugmaker, and Tokyo Electric Power Co., Asia's biggest power producer, both rose the most in three quarters.

Better Quarter

Shares of Takeda Pharmaceutical last week fell 0.4 percent after gaining 6.1 percent in the second quarter. Tokyo Electric slid 0.3 percent following a 7.7 percent advance.

After each of the past three instances that the two groups were leaders, the Asia-Pacific index's performance improved by 11 to 40 percentage points the following quarter.

The biggest turnaround took place in the fourth quarter of 1998. The benchmark rose 27 percent after falling 13 percent in the third quarter as the Asian financial crisis drew to an end.

This time, the index has risen 9 percent since reaching a seven-month low on June 13, en route to a 3.1 percent loss for the quarter.

``Stocks have already found a bottom so I expect the third quarter to be much better than the second quarter,'' said Jacky Choi, who helps manage $3.5 billion at Value Partners Ltd. in Hong Kong. ``Now is the time to sit down, do your homework and see which stocks are undervalued and which aren't.''

Hong Kong, China

Choi recommended investors focus on companies that will benefit from rising spending in Asia, and favored real estate, consumer and financial companies over exporters. Hong Kong and Chinese companies are trading at reasonable prices considering they will probably deliver 10 percent to 15 percent growth in earnings this year, he said.

Both the 33-member Hang Seng Index, Hong Kong's benchmark, and the Hang Seng China Enterprises Index, composed of 38 state- controlled Chinese companies, are valued at 13 times estimated earnings, according to data compiled by Bloomberg. At their second-quarter peaks, they were valued at up to 15 times.

Most markets in the region tumbled during the past two months on concern that rising borrowing costs will trigger a global economic slump. The MSCI Asia-Pacific Index plunged as much as 19 percent from a record set on May 8. The U.S. Federal Reserve and the European Central Bank both lifted interest rates during the rout, which lasted until June 13.

Asian Demand

F&C Asset Management's Williams said he's using the slump to buy stocks that will benefit from economic expansion in Asia, especially China. His picks include Ping An Insurance Group Co., China's second-largest life insurer, and China Infrastructure Machinery Holdings Ltd., a maker of earth-moving equipment.

Shares of Ping An Insurance fell as much as 18 percent after closing at a record HK$23.90 on May 9. They have since rebounded to HK$23.10. China Infrastructure Machinery declined 20 percent from its high. Both are so-called H shares, members of the Hang Seng China Enterprise Index.

Tim Rocks, an Asian equities strategist at Macquarie Securities Ltd. in Hong Kong, also favors stocks that will benefit from growth in the region.

``I think you'll see a divergence in the second half,'' he said. ``Those stocks that are exposed to domestic demand in Asia will do quite well, but those stocks that are exposed to global demand, U.S. consumers, U.S. growth, might suffer.''

Japan, China

In Japan, Asia's largest economy, unemployment has fallen to a seven-year low, wages are rising and consumer confidence is close to a 15-year high. Shares of Rakuten Inc., the nation's biggest online retailer, have gained 5.3 percent this month after plunging 36 percent in the second quarter.

China's economy, the region's second-biggest, will expand 9.5 percent this year as domestic demand strengthens, according to the World Bank. Retail sales rose in May by 14.2 percent, the fastest pace in more than a year. Auto sales surged 31 percent in the first five months of 2006.

Even as Asian economies improve, riskier stocks remain out of favor with some investors.

``The best thing to do is remain with a defensive- orientated portfolio,'' said Michael Watt, who helps manage $2 billion of Asian investments for Henderson Investors Plc in London. ``We don't expect the third quarter to be a particularly strong environment for Asian stocks.''

U.S. Rates

Exporters such as Toyota Motor Corp., LG Electronics Inc. and Taiwan Semiconductor Manufacturing Co. led second-quarter losses in Asian stocks on speculation that rising U.S. rates will hurt sales of cars, plasma televisions and cell phones.

Those concerns are likely to last for a while, said Yoon Lai Choo, who manages $1 billion at Comgest (Far East) Ltd. in Hong Kong. The Fed on June 29 raised its key rate for the 17th straight time and said there may be further increases.

``We actually think interest rates may peak later than sooner,'' he said. ``Defensive stocks will likely be in favor again this quarter.''

For investors such as F&C Asset Management's Williams, health-care companies and utilities are too conservative to buy. Asian demand, rather than U.S. rates, should be at the forefront of investors' minds, he said.

``I don't think it matters if the Fed has had its last rate increase or we have one more or so,'' Williams said. ``What's important is investors should start to look through the cycle, and look for more fundamentals and growth.''

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To contact the reporter on this story:
Ian C. Sayson in Manila at  isayson@bloomberg.net

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