Investment themes in China and other emerging markets


American Century Investments

City view of Shanghai, China

We continue to see investment opportunities in China and other emerging market (EM) countries as growth and vaccination rates approach those of developed markets.

The effects of COVID-19 surges, China regulatory changes and inflationary pressures may diminish as we move into 2022. We believe positive earnings estimates, growth potential and valuation data all favor emerging markets and support a positive outlook. Below, we review the current market environment, recent challenges and opportunities.

 

China policy implications: short-term uncertainty vs. long-term headwinds

Recent government regulations imply China is prioritizing social fairness and stability in areas considered important to public interest or strategic policy goals. Examples include boosting discretionary income and population growth — consistent with government leaders’ stated emphasis on fair growth and common prosperity.

The regulatory policies are intended to create a fair and orderly business environment for sustainable development, with the main objectives to:

  • Contain financial risk: regulate debt levels for property developers and internet finance companies
  • Reduce monopoly power: eliminate exclusivity in merchant contracts or platform choices
  • Improve data security: increase government oversight to regulate the collection, storage and use of consumer data; strengthen cybersecurity to reduce national security risks for overseas listing of data-rich companies
  • Reduce social inequality: promote social fairness and wealth creation; improve health care access and reduce medical costs; ease the burden of education expenses; increase the supply of rental and social housing
  • Reform capital markets: support the continued opening of China’s financial markets and financial sector to foreign investors; promote a healthy domestic stock market by reducing volatility and speculation; strengthen supervision of companies listed overseas (i.e., American depository receipts and initial public offerings)

Recent regulation changes are related to China’s long-term development and modernization agenda. Therefore, we may see additional regulatory changes in areas fundamental to the well-being of citizens such as health care services, food and drug safety, housing and labor protection. Though additional regulations are likely, the most stringent changes may have already been made.

Companies positioned to address China’s economic agenda continue to receive strong policy support. For example, we see opportunities surrounding electric vehicles, cloud computing and health care innovation.

 

Pandemic: Delta Influence on emerging market economies

While the Delta variant renewed COVID-19 concerns, we expect any other surges to be a temporary speed bump to recovery, not a permanent roadblock. Select countries may likely see their 2021 gross domestic product (GDP) growth forecasts revised lower. But we believe the revisions may be minor, accounting for pandemic lockdown measures and their impact on domestic demand and consumption. We think this may delay growth until 2022, rather than eliminate it.

 

Earnings momentum: positive trends in emerging markets

Recent company earnings data trends are favorable for EM equities. We believe the upswing may continue throughout this year. Second quarter 2021 earnings announcements have been strong, supported by relaxation of COVID-19 restrictions and a pickup in economic activity.

Despite generally positive earnings growth, EM and U.S. equity performance has been very different this year. While valuations of U.S. stocks have been elevated, EM equities are slightly negative for the year, impacted by recent weakness in China. This implies the correlation between EM earnings and equity performance is low by historical standards.

 

Growth: potential for higher ceilings

All three economies in EM North Asia (Mainland China, South Korea and Taiwan) have fully recovered in GDP terms, in stark contrast to other regions. EM ex-North Asia has more room to reflate relative to other regions as growth in many of these economies remain below pre-pandemic levels.

We expect speed of growth to build in EM economies that have taken longer to exit the pandemic, and we are watching cyclical sectors with a focus on reopening and reflation. We’re finding opportunities in materials — including infrastructure spending through holdings in cement and steel — and financials, driven by increasing economic momentum.

 

Valuations: Emerging markets are compelling relative to developed markets

We believe EM valuations, relative to developed markets, remain attractive. The price difference between the two is notable, considering that EMs have shown earnings growth and earnings revisions comparable to those of developed markets. Asia, Europe, the Middle East, Africa and Latin America are each trading at higher-than-historical-average discounts to the United States. Latin America has the largest valuation gap.

 

Conclusion

Recent short-term volatility has created opportunities for long-term investors, and this year’s various challenges should become less problematic over time. Regulatory changes will likely continue in China — particularly in areas with important social welfare implications — but the worst may be behind the country.

We think EM may start to perform better into year-end and in 2022 as countries are able to secure and administer vaccines. If you’re interested in how an allocation to emerging markets may support your portfolio diversification and investment goals, we recommend a discussion with your Ameriprise financial advisor.