2022 could well be remembered as the year of the reopening trade in emerging markets – when their economies bounce back strongly from Covid-related restrictions. While most developed countries have rapidly vaccinated their populations against Covid and have reopened, emerging countries have lagged. When emerging countries’ vaccination programmes catch up, their economies will reopen quickly, and this could strongly support their stock markets.
As the pace of vaccination increases in the emerging world, local economies will recover and investment sentiment should improve – and the gap in stock market performance will narrow, in our view. In 2021, emerging markets stock markets have underperformed in aggregate compared to developed markets, dragged down by China. By contrast, India, which we have long favoured, has outperformed developed markets on average this year. India took a less restrictive approach to Covid than China, and prioritised reopening its economy. India’s GDP growth in 2021 has been much stronger than China’s, and this is likely to continue into 2022.
China suffered three main headwinds in 2021, all of which we think could abate in 2022: a slowing economy, problems in the property sector, and tougher regulation.
China has deployed one of the toughest responses to Covid in the world, and this decelerated its economic growth. In the third quarter, GDP growth was 4.9% year on year. (At the beginning of 2021 forecasters were predicting above 8%.) We think an increasing number of top Chinese policy makers have become concerned at the economic slowdown, and that China could ease monetary policy in 2022, when the developed world – faced by inflation – is likely to be tightening.
Emerging countries in general have not used ‘helicopter’ money (increased government spending and stimulus) to the extent of Europe and the US and therefore will not suffer the same degree of monetary policy unwinding or fiscal drag as developed countries in 2022, in our view. Headwinds may turn into tailwinds.
That said, we need to acknowledge that the growth model in China has permanently changed. We should not expect GDP growth numbers of 8% again from China. Growth between 4% and 5% GDP would still be excellent for such a large economy – the second largest in the world. Future growth in China should be sounder. It will most likely come with less debt, be less reliant on property investment, and will be more centred on the consumer.
There has been much misunderstanding of China’s move toward tighter regulation in 2021. To see a retreat into some kind of Maoist dystopia would be alarmist. We understand it as part of China’s drive for “common prosperity”. The Chinese administration wants to move away from growth at any cost, toward better quality growth and greater inclusion of all parts of society. This is very good for companies focused on the consumer.
Macroeconomic analysis can only go so far when it comes to investing in emerging markets. Our approach is to search for the very best quality companies within emerging markets, with durable franchises and persistent profits protected by strong moats. Quality businesses are resilient, and less dependent on the overall state of the economy. We look at stocks as businesses and hold them for the long term. As famed investor Howard Marks said: “Performance doesn’t come from what we buy or sell, it comes from what we hold. Our main activity is holding”.
We believe that the great advantage for quality companies in emerging markets is that they enjoy a long runway for strong growth, whereas in developed markets, in many cases that runway has all but ended.
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