EM ready for a comeback, but volatility will remain high
Emerging markets (EM) performance has been held back over the first three quarters of 2021 by a few factors, including the spread of the Delta virus variant in less vaccinated countries, news out of China (growth slowdown, regulation crackdown, and the housing slowdown alongside the Evergrande fallout), and the upcoming Fed tapering. Although some idiosyncratic risks remain and uncertainty is high, we believe that most of the bad news is behind us. As such, EM should manage the current situation and they are better positioned to do so than they were in 2013, when the Fed first tapered its purchase programmes. A few elements support our view:
- the peak of the Delta variant is behind us;
- the vaccine rollout has speeded up in low-income countries;
- the Fed’s tapering will be gradual, with likely limited impact on global financial conditions;
- the EM-DM growth gap should widen in favour of EM; and
- China’s policy stance is becoming more accommodative to avoid a hard landing.
In 2022, investors could play EM opportunities in different ways. With global yields at historic low levels, EM debt is an income source. Inflation should be less of a concern for hard currency (HC) bonds, while – in the local currency (LC) space -- our conviction is with countries where the tightening cycles are almost complete. Other segments may also be considered, such as corporate and green bonds, as the green transition will accelerate further in the coming years. We are keeping a neutral view on EM currencies due to the poor risk reward at this stage. EM equity offers good value in terms of relative valuations in a global context, with room for a catch-up. Global investors’ positioning is light. As EM are a heterogeneous pool, investors should be selective, active, and flexible, while monitoring two main global risks: growth and inflation trends. China could face additional regulatory constraints, but we remain constructive on Chinese assets in the long term for structural reasons. India could benefit from China’s slowdown and it is a bright spot within Asia.