Will China et al ‘Emerge' as a key asset class this year?

Everywhere you look you will see the produce of emerging market economies embedded into our lives - from the microchips in our phones to our morning coffees
Mark Rooney

WE'RE just one month into 2022 and the world's financial markets have already seen quite a lot of volatility across a number of different asset classes.

Numerous factors have been at play over the last few weeks, including the latest inflation figures posted in the US, UK and EU, supply issues and political tensions pushing up oil prices, and concerns around Omicron's potential impact on Chinese production lines.

This week we'll take a look at the investment opportunities presented by Emerging Market stocks and some readers may be surprised to learn that China sits within this class.

Emerging markets (EM) is a broad term used to cover countries that do not yet have fully developed financial markets and economies, compared to developed markets such as the US, the UK and Japan. Emerging markets cover many geographies, from South America and Mexico to Russia and India. Interestingly, given its status as a true heavyweight on the global stage, China sits as the primary market within this category.

It's fair to say that there have been plenty of challenges for EM countries over the last 12 months or so. Generally speaking, slower vaccination roll-outs and smaller fiscal responses have contributed to weaker-than-expected recoveries from the pandemic.

Unfortunately, most EM countries don't have the luxury of providing the same level of government support as their developed market (DM) counterparts, which explains the gulf in recoveries during 2021 versus, say, the US or UK. Equally, we've seen a more aggressive response from EM central banks in response to spiking headline inflation.

As for China in particular, they also experienced a slower-than-expected economic recovery. This is partly due to their zero-Covid policy, which was (and arguably remains) a costly economic trade-off. Many industries in China have also been subject to a regulatory shake-up. On top of this, the outlook was further dampened after Evergrande – China's second largest real estate developer – defaulted.

Regular readers of this column may recall we looked at this back in October. Suggested comparisons to Lehman may have been exaggerated, but the impact is far from negligible. China's property sector accounts for a disproportionate amount of its economy, so a weaker property outlook will put a drag on what has been a large growth engine there in recent years.

All of this has resulted in EM equities substantially lagging their DM counterparts last year. Though past performance is no indication of future performance, most of this has been as a result of valuations decreasing, not a lack of earnings growth.

EM investors are therefore asking a big question for this year - are EM equities now cheap enough to make them worth a look?

The outlook for 2022 certainly does appear brighter for EM stocks generally. However, the asset class covers such a diverse grouping of very diverse countries, with each at different stages of development, so there will always be some areas that offer more attractive investment opportunities than others.

Several fund managers continue to see long-term promise in India, underpinned by reform progress in the country. There is also some positive sentiment for the Eastern European markets of Poland and Hungary, where economic growth is strong and stock valuations are reasonable. Russia is another market favoured by some, given cheap valuations and as it is a beneficiary of the higher commodity prices seen over the last year.

Despite these opportunities for the professionals, it is understandable for less experienced investors to consider Emerging Market economies to be of lesser importance in the financial ecosystem.

However, everywhere you look you will see the produce of these economies embedded into our lives - from the microchips in our phones, to our morning espressos, even to the shirts of our favourite football teams. Developed market economies import a huge amount of goods and raw materials from EM countries and have become quite reliant on them for everyday things.

It is those very companies which produce, manufacture and transport many of these goods which sit within the Emerging Markets stock markets. Therefore EM stocks should unquestionably have a place in well-diversified portfolios.

The question, as ever, is how to balance their risk and reward profile versus other asset classes. As last year highlighted, investing in EM assets comes with risk considerations which can be quite different to those in developed markets, so as always, it is recommended that you speak to a professional for guidance if you're thinking of “emerging” into something new.

:: Mark Rooney is a wealth manager at Barclays Wealth and Investment Management in Belfast.

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