Emerging Markets – too big and cheap to ignore in 2022Emerging Markets (EM) will be entering 2022 from a low base after their recovery was hindered by the resurgence of COVID variants, China’s regulatory crackdown and concerns of a more hawkish Federal Reserve (Fed). We expect 2022 to be another reversal of fortunes, quite like 2021 was a reversal of 2020. What makes us confident of the turnaround is – renewed policy easing efforts in China, an improvement of fiscal & current accounts in EM, continuation of global growth and rising trade volumes alongside an uptick in the pace of digitalisation and decarbonization.
Strong global growth backdrop, rangebound dollar to benefit EM
EM growth remains more sensitive to the state of the world than Developed Market (DM) growth as they are highly dependent on global factors to drive local growth. 2021 has shown us that while we are far from resolving the COVID-19 pandemic, corporations and governments worldwide have learnt to cope with the peaks and troughs of the pandemic. For this reason, we remain optimistic that global growth is set to remain on track in 2022 which should not only reduce demand for safe haven US dollars but also bolster structural forces to foster EM growth in 2022.
A key hurdle facing EM investors is the more hawkish stance by the US Federal Reserve. The Dec 15th Fed’s minutes clarified that the more aggressive orientation toward policy extends to the reduction of the balance sheet starting in 2022, thereby implying a first-rate hike by June 2022. The markets are pricing in more than a 81% probability of a Fed rate hike by March 2022 following St.Louis Fed President James Bullard’s comments. While a more aggressive rate tightening would be a headwind for EM, we believe EM economies are in a much better position to withstand the rising rate environment owing to their stronger fiscal and current accounts balances. Higher commodity prices have also been a windfall for the exporter. Central banks in EM have remained vigilant and some have already raised rates to tackle inflationary pressures – including Russia, Brazil, Chile and Peru.
It’s different in China this time
The experience of 2021 shows us that Chinese policymakers appeared intent on reducing the economy’s dependence on investment in the real estate sector and gear the economy towards consumption of more domestic goods and services. This clearly did not pan out as planned and by the end of 2021 Chinese policy makers finally threw in the towel and mobilised forces to re-stimulate the economy. The economic restructuring of resources away from real estate towards agriculture, energy and technology will be a more long-term project by China, Inc. than originally planned. It is amply evident that Chinese authorities have a pro-growth agenda, have given way to renewed policy easing and are willing to utilise the tools when needed. East financial conditions in China have been an important tailwind for economic and provides an important positive ripple effect for broader EM. The regulatory crackdown in China last year has been an important headwind for EM investors. However, it is expected to ease with the culmination of the Chinese Communist Party’s 20th National Congress, as it has in past political cycles.
A differentiated approach to investing in EM via non-State-Owned Enterprises (SOE)
One of the big differences between DM and EM stocks lies in their ownership structure. The largest share of EM companies are SOEs, in which a government entity has significant (more than 20%) ownership control. China has one of the highest proportions of state ownership within EMs. Notably, the rise in default rates of SOEs within China has certainly played a role in turning investors’ attention to non-SOEs. We have held the view for a while now, that non-SOEs have displayed a structural advantage versus SOEs in terms of higher performance, higher quality (ROE and ROA) and lower leverage . Owing to the lower degree of state ownership, non-SOEs also have an inherent tilt towards ESG via better corporate governance and environmental considerations. The WisdomTree EM ex-SOE ETF enables investors to capitalise on the long-term growth opportunity of EMs whilst limiting exposure to SOEs. It aims to deliver two important factors such as long-term growth and quality as it screens for companies with significant government ownership. This is evident in the table below from the relatively higher long term growth rate and quality metrics compared to its peers.
