2022 EM Equity Outlook: Views on Fed Hikes, China and Russian Tensions
1) With US rates expected to rise later this year, are you worried about the prospects for emerging market (EM) equities?
In our view, some investors have a misperception that higher US rates are bad for EM equities. If the Federal Reserve begins a hiking cycle, we would not anticipate much negative fallout for EM economies. In fact, we believe EM macro fundamentals are currently quite healthy and external vulnerabilities appear low. While inflation has picked up sharply in EMEA[i] and Latin America, it has forced central banks in these regions to start hiking rates well ahead of the Fed. China, on the other hand, has experienced subdued inflation and is currently easing monetary policy, with more pro-growth fiscal and monetary policies likely to come in 2022. We believe the Chinese economy could start to see sequentially rising growth from 4Q 2021 to 4Q 2022. The renminbi has been strong due to high current account surpluses, which should give the People’s Bank of China more room to ease. Furthermore, US dollar-denominated debt woes in China’s property sector has not spread contagion to other sectors. Outside the property sector, China has little exposure to unhedged US-dollar debt. India and Indonesia have improved their balance of payments and the World Bank has projected that these economies will be among the fastest growing in 2022. In addition, some EM countries, such as Korea and Taiwan, are typically more sensitive to global growth than rates.
We have a positive view of the ASEAN[ii] region, which was severely hit during the last US tightening cycle. Many of these economies may be on the cusp of a positive credit cycle due to structural space for leverage that could help drive GDP growth. Vaccination rates have increased significantly over the past few months, and 50% to 75% of the populations in many of these countries are now fully vaccinated. Inflation in ASEAN has been much lower than in the US and Europe due to excess capacity and a net benefit from supply chain disruptions. Global semiconductor shortages have benefited chipmakers in Korea, Taiwan and Malaysia. In our view, the US-China tech war should continue to drive chip manufacturing and assembly out of China and into ASEAN. We believe rising prices of commodities like coal, palm oil and natural gas will continue to benefit Indonesia and Malaysia, while commodity importers like India and the Philippines should withstand higher prices due to high foreign exchange reserves and strong external accounts. Valuations in many ASEAN equity markets appear inexpensive as we expect earnings to grow from a very low pandemic base. Many ASEAN currencies also appear cheap. In our view, inexpensive valuations, cheap currencies and low foreign debt and equity positioning (unlike the last US tightening cycle) should support ASEAN equity markets in 2022. Our biggest concern is a Fed policy mistake, particularly if the Fed becomes too aggressive in an environment when growth in the US might be slowing.