In 2020, it was China; In 2021, it was EM ex-China; Who is going to be the big winner in EM in 2022?
The diverging performance between the key regions in the developing world over the last 2 years is not a surprise given the significantly differing factors that drives these different markets.
In general terms, China is a domestically-driven earnings market and therefore a play on Chinese demand; whereas EM-ex-China is much more of a global cyclical play with its high levels of commodities and semiconductor exposure, both of which have highly cyclical earning profiles that ultimately represent a play on global demand.
The investor bases are also different. In the case of China, this is a market that is mainly driven by the domestic retail investor, whereas in most of the other Emerging Markets, foreign investors are the swing factor for how the market reacts.
If you break down the EM-ex-China region even further, it essentially has two main components, (1) the technology/semi-conductor exposure primarily found in Korea/Taiwan and, (2) the commodity exposure that you primarily find in Eastern Europe, Middle East and Africa. Predictably, these markets have done extremely well this year given the increase in commodity prices and the very constructive semiconductor cycle.
What do see for 2022:
In China, the companies in our portfolio still throw off large amounts of free cash flow and continue to deliver strong earnings growth. While China as a whole is slowing down and the absolute growth levels might be lower than in the past, these are still some very big positive numbers. We are also seeing the housing market in the process of rolling over and indeed house prices falling which would likely lead to a rotation back from housing into the stock market from the domestic retail base. Both of these factors are a tailwind for Chinese equities, especially the strong earnings profile which is typically the signal that foreign investors look for before moving into the market. Moreover, the Chinese policy-makers have also started softening their stance on the recent regulations which should provide more comfort for investors. We are overweight Chinese equities heading into 2022.
With regards to the Asia-ex-China markets, we are seeing more data points that suggest that we are at or near the peak of the semi-conductor cycle which could limit the overall upside in 2022 for the Korea/Taiwan region. Instead, we are picking the South East Asian markets to outperform in the Asia “bucket” in 2021, this includes Malaysia, Indonesia, Thailand, amongst others. These economies will see stronger growth heading into 2022. Whereas other economies rebounded with very strong growth rates this year, the South East Asian region continued to experience lockdown induced economic weakness for a large part of 2021. The recovery has been pushed forward into 2022 for many of these markets which provides a lot of opportunities in the equities space.
We expect global demand and global growth to remain strong in 2022, which will lead to continued demand for commodities. This is positive for the commodity exposed countries. Our Russia team also highlights that Gazprom is now trading with ~15% gross dividend yield for 2021 and based on their forecast, they see energy and materials sectors trading with double digit dividend yields for 2022 as well. We are overweight Russia in our portfolio.
Finally, a very unpopular place to be in Emerging Market equities these days is in Latin America. For Brazil, it comes down to the political and economic policy uncertainty which has kept investors away and led to the underperformance. Much to the disappointment of our Brazil team who continue to find high performing Brazilian companies that are benefiting from both the weak currency and the strong commodity prices. We are not cutting our Brazil exposure but the timing of when Brazilian stocks bounce back is uncertain.