15 Feb 2022
Asia was the first region into the pandemic and the first to come out and many countries benefitted from the strength of demand for manufactured goods in 2021. This was especially true of China, although the stock market was a major laggard for several reasons in 2021. The underperformance of this market as a non-recovery play might have been expected as China was not seen as a reopening beneficiary when it emerged from internal lockdowns earlier than most. China was seen as one of the world’s leading manufacturers and was a clear beneficiary from the increased levels of spending on goods rather than services. The stock market suffered from the regulatory crackdown on the large technology companies which are important index constituents and these increased levels of scrutiny have adversely affected the profit outlook in the short term at least. In addition, concerns over the slowdown in the residential property market have adversely hit sentiment to domestic businesses supplying the wider housing sector, including household goods companies as well as highly indebted property names such as Evergrande.
The ‘Common Prosperity’ agenda is driving a rebalancing in the economy and will create both winners and losers so there will remain opportunities for active managers to deliver positive returns. There does need to be an emphasis on ESG focussed businesses and responsibility shown to all stakeholders. The authorities in China now explicitly want to see a cooling in property prices, even if this causes short-term economic pain. They are also focussed on reducing emissions which, in the short term, has hit economic activity in certain industries. As a laggard market in 2021, contrarian investors will be drawn to the lower valuation levels now available in the Chinese stock market.
China is continuing with its ‘Dual Circulation’ strategy which is a refinement of the Made in China 2025 agenda. The objective for the country is the creation of globally competitive domestic champions in key strategic sectors, while increasing the level of domestic consumption in the economy to reduce reliance on global macro forces with the aim of China becoming its own growth driver. If the economy does slow more than expected, China remains the one major economy that did not resort to QE and has the potential to cut interest rates from current levels. China will now concentrate on quality rather than quantity of economic growth which perhaps surprisingly could provide a more profitable profit backdrop for many companies.
Funds exposed to Taiwan, which is included in Greater China mandates as well as emerging market mandates, benefitted from the strength in the semiconductor industry in 2021, and the ever-growing levels of digitalisation and AI augur well for the long-term growth prospect for this and related sectors. South Korea has also benefitted from the strength of semiconductors and manufacturing in general and any improvements in corporate governance could see an upward rerating of this market, although it should be borne in mind that there have been several false dawns on this front before.
India has benefitted from its post delta variant economic recovery although the extent of the impact of the Omicron variant has yet to be seen. The reform measures enacted by the Modi administration such as the nationwide goods and services tax and the incentives to manufacturing businesses are also helping sentiment towards India, where the long-term growth runway remains intact. Compared to North Asian neighbours, India should benefit from the under penetration of many basic goods and services such as autos, retail, and banking. The country’s current account weakness has improved significantly, aided by the phasing out of expensive and wasteful fuel subsidies. The recent strength in the oil price is no longer the concern it once was and shouldn’t be an issue if oil does not rise significantly from current levels. In 2021, India benefitted from its status as an emerging market where ‘rule of law’ prevailed and undoubtedly attracted some assets which were switched out of China as regulatory uncertainty and fears of political interference in that market increased.
Among the other Asian markets, the ASEAN region is no longer the market darling it once was and as a result, valuations no longer trade at premium levels. As the effects of Covid-19 on their economies pass over time, it seems safe to assume the long-term positive trend in domestic consumption will resume. There are now attractive opportunities for longer term investors. Indonesia continues to have favourable demographics and is a beneficiary of higher commodity prices. The Philippines also has some attractive opportunities with this market once among the most highly valued in Asia. Both countries continue to have competitively priced labour markets that have the potential to attract inward investment. Even within Singapore, several listed banks have exposure to the ASEAN region and should benefit from rising US interest rates and bond yields. The region trades at close to record discounts in valuation terms vs developed markets.
Within Latin America, Brazil has been a volatile market as rising inflation has caused significant increases in interest rates, slowing the economic recovery. There are also concerns about the election due later this year with polls suggesting the return of a left-wing government under former President Lula. Mexico has taken a different approach to Covid-19 than many countries, allowing the economy to remain broadly open. While this has naturally impacted on coronavirus cases and deaths in a negative way, it does mean that the country is emerging from the pandemic with a lower fiscal overhang than most of its LATAM neighbours. The post pandemic recovery has been sluggish and rising inflation has forced its central bank to raise interest rates. The important auto sector suffered from global chip shortages in 2021 but this should improve as this year progresses with increased levels of capacity in the semiconductor industry.
Investor uncertainty remains over left-wing President Obrador’s economic policies, but Mexico should benefit from the strength of the US economy in 2022 and beyond. Chile has suffered from political turbulence and the election of a left-wing regime in a country which had previously shown high levels of political and economic stability within the region, although it has not been able to shake off the regional problem of high levels of inequality which explains the election outcome. Despite the strength in commodity prices, Latin American currencies have been weak and have detracted from returns. In 2021, the Brazilian real vs the US$ suffered its fifth consecutive year of devaluation, losing nearly 7% and in Columbia, Chile and Argentina suffered double digit declines. The market has perceived that, while the boom in commodity prices has benefitted certain companies in the region, this hasn’t translated into wider economic prosperity.
In Russia, the economy has benefitted from the recovery in the oil price although overall domestic demand remains supressed. One area to watch for is the threat of further economic sanctions if tensions with Ukraine worsen further or if there is military action in that region. Outside of geopolitics, the economy remains placed to continue its post Covid-19 recovery.
South Africa epitomises the disappointment of Africa as an investment opportunity where 27 years after the ending of apartheid it remains a very unequal society and much of the population lives in abject poverty with high unemployment. Violence and corruption have undermined society and only time will tell if the continent can ever deliver on its potential. Within certain markets such as South Africa and Nigeria there are well run companies, but often local currency returns have been diminished by currency weakness. There are banks in Nigeria delivering strong ROE, but the returns are in naira not euros or US dollars. Among the smaller African markets, there will always be opportunities for strong stock pickers, but these markets are not liquid enough for larger, well-established funds to take meaningful positions.
A positive for the emerging market region is the overall lower levels of vaccination rates with Indian and the smaller Asian countries significantly lagging the developed world, especially when it comes to double vaccination. This allows scope for a further economic reopening and catch up over time although it may be into 2023 when this is finally seen. The major risk to the region remains faster than consensus US monetary tightening which, if combined with a very strong US$, generally results in stock market and economic weakness. Overall, the region has raised interest rates ahead of the developed world in response to rising inflation and this was a major factor behind the underperformance vs developed markets in 2021. In contrast to 2013 when the Fed Taper Tantrum hit this asset class, local currencies do not look overvalued, current account deficits are more robust and foreign exchange reserves improved. The asset class, unless US monetary policy upsets the apple cart, should benefit from continued economic recovery in 2022/23, allowing the region to deliver positive earnings growth. There are some reasons for optimism on the domestic front but the influence of US monetary conditions on the region should never be underestimated by investors.
Graham O'Neill, Senior Investment Consultant
The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.
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