Nov 23, 2021
Portfolio Manager Archie Hart identifies catalysts for a more positive 2022 outlook.
There are two primary reasons for this. Firstly, in China, we have seen a major regulatory crackdown, as well as an economic slowdown and then the near bankruptcy of major property developer Evergrande. The second issue has been the interest rate tightening underway in a number of emerging market economies. Rates in Russia, for example, have increased from 4.25% to 7.50%, while rates are also higher in Brazil and a number of other countries. In effect, the punch bowl has been withdrawn from emerging markets before the party ends, which is not the case for developed markets.
Conflicting forces are interacting across global markets - strong growth, high inflation and generous stimulus. Clearly, the chances of all these coexisting for long are quite unlikely. As the relationship between them recalibrates, we are likely to experience volatility in all markets, whether developed or emerging. But the regulatory crackdown in China is now a year old, and well understood by markets. Once this has run its course, domestic policy should gradually become supportive. This is because when China’s policymakers realise that growth has slowed, we should see the introduction of much more stimulative policies, which should be beneficial for the broader emerging market asset class as well.
With a lot of the stimulus already withdrawn in emerging markets, I think they now offer upside compared to developed markets, where the transition is yet to take place and where the situation could start to look more difficult.
Another feature we tend to gloss over is that the vaccination programmes in emerging markets, which have been much slower than in developed markets, are really gathering pace. Hopefully, as we move into 2022, COVID and its associated disruption will start to dissipate. That means we should gain more visibility on growth while facing lower market volatility, which I think is going to be an important positive across emerging markets.
I think there is some very interesting value around. If you look at emerging markets, they are trading at about a 40% valuation discount compared with developed markets. That’s the widest for 15 years. I believe we have worked through much of the bad news, but the market is still pricing them as current events, which makes me feel much more positive on a 6-to-12-month view.
We are cautious on China at this point, as you would expect, and underweight. We think there will be progressively more interesting opportunities in that market during the course of 2022. We will look to align our ideas with that government’s priorities, so are looking for attractive renewable energy generators benefitting from the carbon transition, as well as domestic brands and businesses supported by the government.
Where we have changed positioning significantly this year has been to increase our weighting in India, where we see a number of interesting opportunities in pharmaceuticals, IT and financial services. We have very little in South America, which is a deeply cyclical market and where, for example, Brazil is going through a very tough time. However, I do think that as we head into 2022, there will be more opportunities in that continent.
I think, lastly, one of the themes over the past year or two has been technology and technology manufacturing. In Asia, we have some of the world’s best hardware and semiconductor manufacturers. I think that theme will continue but we have probably enjoyed the best part of that over the last couple of years. So we will be increasingly selective about companies within that space as well.
Equity investment: The value of equities (e.g. shares) and equity-related investments may vary according to company profits and future prospects as well as more general market factors. In the event of a company default (e.g. insolvency), the owners of their equity rank last in terms of any financial payment from that company. Emerging market (inc. China): These markets carry a higher risk of financial loss than more developed markets as they may have less developed legal, political, economic or other systems.
All investments carry the risk of capital loss. The value of investments, and any income generated from them, can fall as well as rise and will be affected by changes in interest rates, currency fluctuations, general market conditions and other political, social and economic developments, as well as by specific matters relating to the assets in which the investment strategy invests. Environmental, social or governance related risk events or factors, if they occur, could cause a negative impact on the value of investments.