In our new paper EM, Asia, China 2022 market outlook: Building back stability, Zhikai Chen, head of Asia/Global Emerging Market Equities, and David Choa, head of Greater China Equities, examine the critical factors influencing the likely path of EM equities this year. China’s economy has entered a policy-induced downturn, while across other EMs, lingering Covid uncertainties, tighter domestic and global monetary conditions and moderating exports imply near-term market volatility.
Constructive on China equities despite near-term volatility
Beijing has tightened its macroeconomic policies to slow infrastructure and property spending. It has also imposed tougher regulatory scrutiny to resolve domestic problems including wealth inequality and asset speculation. Its primary focus now is on achieving ‘common prosperity’.
We believe Chinese equities should recover gradually from last year’s style rotation and ongoing regulatory tightening. The near-term challenges are unlikely to change longer-term economic recovery trends; data shows that the regulatory cycle generally creates short-term shockwaves, but medium to long-term equity performance is driven mainly by structural growth factors.
These have remained largely intact (Exhibit 1), in our view. Furthermore, the government still has fiscal and monetary ammunition for further selective stimulus, if needed.
There are, of course, potential risks including uncertainties over Covid-19 and its impact on consumption; sharp and sudden monetary tightening; and a deeper-than-expected slowdown in activity.
However, we believe that with stable growth becoming crucial for China in 2022, a more accommodative policy and fiscal environment presents investors with growing opportunities to pick up fundamentally solid long-term winners at more reasonable valuations.
Three themes aligned with China’s structural trends
We favour companies with the highest sustainable growth, and sound or improving environmental, social and governance (ESG) profiles.
We are focusing on three overriding themes that are in line with China’s structural trends:
- Technology & innovation
The beneficiaries stretch beyond the traditional software and hardware enablers to include companies offering genuine innovation. Industrial digitalisation/upgrading has gained pace as the economy progresses up the value chain. Biotech, life sciences, energy transition companies and ‘old economy’ names undergoing a digital transformation of their operations can offer long-term opportunities, in our view.
- Consumption upgrading
Chinese consumers are targeting better lifestyles and the beneficiaries of this trend stretch beyond traditional retail sectors. Services such as healthcare and entertainment are gaining market share. Rising household income, low household debt and more diversified consumer profiles are allowing more and more domestic winners to become multinational corporates.
- Industry consolidation
As China’s growth pace moderates, companies need to look beyond basic revenues and focus more on research & development, productivity and costs. Those with progressive mindsets should increasingly pull away from the competition and likely drive consolidation in both the old and new economies.
EM/Asian equities outlook: Bumpy upcycle amid regional disparities
As growth moderates and the US Federal Reserve starts to raise interest rates, the pace of the economic recovery in 2022 will likely differ among EM economies depending on each country’s Covid tolerance policies.
While China will likely continue its ‘zero-Covid’ strategy, countries such as South Korea, Singapore, Australia and Japan are shifting to a focus on ‘living with Covid’. Rising vaccination rates should allow the sources of growth to broaden from exports to domestic demand.
We see positive structural forces across EMs that are likely to boost long-term investment opportunities – digitalisation being one of the key themes to watch.
With energy inflation and supply-chain bottlenecks easing, inflation will likely remain relatively benign. The monetary policy tightening cycle looks set to get underway in 2022 for most EMs.
Fiscal and current accounts are in better shape now than they were during the ‘taper tantrum’ in 2013 (Exhibit 2).
Careful stock selection is crucial in 2022
Modest valuations, light investor positioning and positive fundamentals are buffers that can help Asian and EM stocks withstand near-term volatility.
Stock selection is critical. We favour
- Selected technology names
- Innovation enablers and disruptors mainly related to the environmental sphere
- Turnaround stories in consumption
- Robust financial companies
- Those companies connected to the Indian and ASEAN digital economies.