By Pierre-Henri Cloarec, portfolio manager of Nordea’s Emerging Stars Equity strategy
It has been a volatile past 12 months for emerging markets (EM), particularly for the regional powerhouse China, where regulatory tightening and property sector strife has weighed on investor sentiment. However, despite continued pessimism towards developing market equities, we see a number of reasons – both top down and bottom up – to be more optimistic for 2022 and beyond.
From an economic perspective, unlike the taper tantrum of 2013, US Federal Reserve policy actions are unlikely to significantly weigh on EM. Compared to almost a decade ago, the current account situation of most EM economies is vastly improved, which minimises vulnerability to external shocks. As for inflation, the market continues to expect current high inflationary prints to subside as the year progresses. Even so, by focusing on dominant EM companies better able to pass through spiking input prices, we believe any additional margin pressure should be short-lived.
As for stock valuations, the EM index is currently trading at a forward P/E of about 12x, which is a 35% discount to developed markets. With global investor allocations to EM equities currently at just 6%, we see significant scope for a reversal of fortune in 2022 and beyond.
Fears drive China to unwarranted discount
Despite a challenging 2021, we are witnessing signs of optimism in China. While China’s widespread policy tightening has undeniably affected investor confidence, we believe the government remains committed to supporting the private sector – which accounts for about 80% of the country’s employment and trade. Nevertheless, the regulatory changes need to be analysed on a case-by-case basis, as the impact on individual companies and industries differs.
As is traditionally the case ahead of the Chinese Communist Party congress – with the next one set for November – the focus of the authorities is set to return to economic growth. China is expected to be one of the very few major economies to engage in policy easing in 2022, at a time when the US will start tightening. Even though volatility may persist in the short term, we believe the current depressed sentiment towards the Chinese equity market – reflected in the large valuation discount relative to developed markets – is unwarranted.
India offers tremendous growth runway
There are signs Indian corporate profits are improving, ending a slowing trend that began in 2011 – which followed a decade of over-investment. The housing cycle appears to be finally turning, with evidence of high affordability levels and low residential inventories. While initially a source of disruption and uncertainty, the structural reforms implemented by Prime Minister Narendra Modi over the past five years have laid the foundations for more transparent and sustainable growth.
While we are cognisant valuation multiples in India are elevated at the index level, bottom-up stock pickers can still identify reasonably valued opportunities – especially in the financial services space. With a GDP per capita of approximately $2000, and a large and young population, India offers a tremendous growth runway for high quality, capital efficient businesses.
Too much negativity priced into Brazil
The macro outlook in Brazil is not as rosy. Inflation has picked up sharply in the last few months, forcing the central bank to hike rates from 2% in March 2021 to 10.75% today. This has triggered downward revisions for Brazilian GDP growth, adding to the negative political and fiscal sentiment.
Despite the pessimism, we feel too much negativity has been priced into the market. As always, short-term overreaction is a great opportunity to invest into solid and sustainable businesses at attractive valuations. Even during difficult times, Brazilian businesses with strong market positions and robust economic moats have continually demonstrated an ability to achieve above-market growth.