Our 2022 scenario for EM equities
Given the global backdrop, emerging market (EM) equities should have performed better than they did in 2021. Yet, China managed to single-handedly drag down the MSCI EM index through its regulatory drive and a significant property slowdown. EM equity investors should also expect to be challenged in 2022, through a combination of tightening US monetary policy, China’s tricky transition to a slower growth regime and less favourable base effects in commodity prices.
We lack notable catalysts for earnings growth at this stage and hence forecast flat 12-month forward earnings for the MSCI EM on a year-over-year basis. Current valuations look fair, although we believe the equity risk premium has room to compress further. We see the 12-month forward price/earnings ratio for the MSCI EM index potentially inching towards 13.5x by year-end. Our 2022 year-end target for the MSCI EM is USD1,350, 4% higher than our end-2021 forecast (equivalent to a ~6% total return). Finding yield in what is shaping up to be a year for the brave may require delving into riskier parts of the EM universe.
As for individual EM markets, we believe Chinese equities could benefit from a re-rating provided: (i) the real-estate sector stabilises; (ii) the authorities provide a credible economic backstop; and (iii) US/China tensions do not worsen. South Korea and Taiwan, which are typical early-cycle plays, may eventually suffer should there be a pause in the pandemic-induced surge in demand for semiconductors. While the signs are good, we worry over the lack of marginal buyers for Indian equities at current valuations, especially if the Reserve Bank of India starts tightening monetary conditions. Earnings in ASEAN countries have not fully recovered from the pandemic and could outperform if economic growth picks up, as we expect, and covid-19 concerns lessen significantly.
We see Latin American equities as generally unattractive despite historically discounted valuations, owing to low economic growth rates (partly due to the rapid tightening of monetary policy), high inflation and persistent political noise throughout the region.
Outside Latin America and Asia, we continue to like Russia, which provides pure exposure to energy prices. The associated geopolitical risk must nonetheless be monitored carefully and could be diversified away via exposure to other oil exporters, such as Saudi Arabia.
All in all, 2022 is shaping up to be a year for the bravehearted, when finding yield may require delving into some of the riskiest parts of the EM universe. Buyers beware!