Emerging markets (EM) faced a backlash in 2021 as a consequence of the Chinese slowdown, rising inflation and – at the end of the year – a more hawkish Federal Reserve (Fed). As such, investors, including us, have been cautious and very selective on EM assets.
Some reasons for caution still remain: Russia-Ukraine tension, uncertainty on the Fed’s tightening path and the overall hot inflationary environment, to name the most impactful. However, we see some mild improvements this year in the EM landscape, with more optimistic conditions for looking at EM assets building thanks to four elements:
- Contagion from the Omicron variant is peaking and the impact on EM has been milder in comparison to previous waves, thanks to the accelerated vaccination campaign in Q4 and more limited restrictions.
- The recovery is ongoing with some countries benefiting from the sweet spot in commodities.
- Most EM have already acted to cool down inflation and most of the tightening cycle is behind us, especially in Asia.
- In China we have seen a significant turn in policies and attitude from the authorities, who are willing to stabilise the economy, while continuing to deleverage the real estate sector
The picture for the EM landscape will remain very varied, based on the country-specific features of their economic models, and different stages in the monetary policy cycle. The effective fragmentation of the EM puzzle could offer opportunities along the following lines:
- Look at areas with lower/non-inflationary pressures, where monetary reaction is on its way or close to peaking, and real rates are back in positive territory. In this respect, Asia presents a benign picture and, in China, the PBoC has already moved towards easing. Chinese bonds can be seen as a good diversifier for fixed income, and more so at a time when developed market central banks are close to raising rates.
- Favour countries exposed to the commodity cycle and which could benefit from higher commodity prices for cyclical or structural reasons (energy transition).
- Play the internal demand story, either within a well-diversified portfolio, actively investing in this theme, or by gaining exposure to China or India which are shifting their economic models towards domestic demand.