Market weekly – Emerging markets head into 2022 in better shape

Listen to the podcast with Zhikai Chen, head of Asian equities, as he discusses the reasons for being cautiously optimistic, or read the article below:

A number of factors justify our hopes for a better year after the challenges that 2021 brought to Asian equities, and northern Asian equities in particular.

Bouncing back from a low base

Most Asian economies, as well as many global emerging markets, will be coming into 2022 from a low base. The recovery in many Asian economies was hindered by the resurgence of the Delta variant over the summer, resulting in more sustained lockdowns and travel restrictions.

While this marked a reversal of what happened in 2020, when Asian economies handled Covid better, this low base should provide tailwinds to the recovery alongside other factors such as brighter household finances that were supported by fiscal measures. We should also note the positive wealth effect that fiscal and monetary support has created in many developed economies and the boost to demand that has engineered. That should rub off on a lot of emerging markets.

On the pandemic, while the implications of the emergence of the Omicron variant are still being assessed, this time around vaccination rates are much higher than they were at the time of the Delta outbreak. That should limit the need for drastic containment measures and by extension the disruptive impact on economies. After a slow start, economies such as Singapore and Malaysia are among those that have vaccinated the vast majority of their eligible populations.

Dealing with Fed action in 2022

Of course, there are some concerns too. What about the outlook for inflation? How will central banks react?

Here, we believe that the balance sheets of most Asian emerging economies are quite healthy, so more resilient, when compared to these of the economies of eastern Europe, Africa and Latin America. The outlook, though, will depend on the pace and the extent of US interest-rate increases, especially given the recent more hawkish comments from the Federal Reserve chair on inflation.

There are two scenarios. If the Fed’s monetary tightening comes amid robust economic growth of 3% to 4%, it would reflect the strength of the US economy. The impact on growth, and demand, should be contained in most Asian economies, and in the wider financial markets, since the rate rises should be limited to the first half of 2022.

If, however, inflation remains sticky at 4% to 5%, the Fed could be seen as being behind the curve, policy action might stretch into the second half of the year and markets would react poorly.

Whatever the scenario, two economies look more vulnerable: Indonesia and India fund a larger part of their financing requirement in hard currencies such as the US dollar and that currency exposure leaves them susceptible to a higher financing cost as a result of rate rises.

Regulatory concerns and the listings pipeline

Another potential cloud on the horizon is regulation in the technology sector where particularly in China we have seen Beijing impose tighter rules on sectors ranging from ride hailing to ecommerce. This has left Chinese internet companies trading at a deep discount. Regulatory risk could raise questions over the valuations of other companies coming to the market, not just in China, but elsewhere in Asia.

However, there is a silver lining to this cloud: away from the Chinese internet giants, we are seeing other big players emerge outside of China as Asian companies replicate the business models of the Chinese majors in countries such as India, Singapore, and Indonesia. Here, e-commerce is deepening.

This is allowing investors to tap into the same type of structural growth that has been observed in China. They should also be aware that valuations are not low as they try to benefit from the potential for strong growth in these sectors.

As for the deep valuation discount in China, we believe it might take a few more quarters before the regulatory action is completed. We will then need to assess the guidance of Chinese internet companies as regards a stabilisation of the regulation and their growth outlook. We expect ecommerce to continue to penetrate Chinese life.

Overall, then, the risks for Asian and global emerging market equities going into 2022 look manageable to us at this point. These economies do not have the firepower that developed economies have, so the challenge for policymakers will be how to balance the gradual withdrawal of the extraordinary fiscal measures. Overall, though, we are cautiously optimistic.

Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. The views expressed in this podcast do not in any way constitute investment advice.

The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.

Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).

Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.