Comment on Q4 2021 & outlook for 2022
Looking back at the financial markets in 2021, we can conclude that equities largely followed our positive outlook for the year. Global equities advanced by a lucrative 22.4%,[1] despite inflationary headwinds and new Covid complexities, thanks to unequivocally-strong global growth and robust corporate earnings. Continuously strong earnings seasons and low real interest rates were pushing investors to follow T.I.N.A (There Is No Alternative) impetus, and to pile further into equities. Only in the last few months of the year did markets start to price in the accumulating risks, with fears of stagflation creeping in. Supply shortage concerns, combined with worries about peak growth, shook the market in September, while the emergence of the Omicron variant and hawkish taper remarks by the Fed chairman sent the markets into correction in November. But still, strong global growth was enough to fend off the risks, pushing global equities to end the year enticingly close to all-time highs.
However, the year also posted some of the highest divergencies between developed markets (+22%) and emerging markets (-2.5%), and even between emerging markets (-2.5%) and emerging markets ex-China (+10.0%). China, the largest emerging market, has underperformed significantly on the back of damaging regulatory actions. We believe that some of the emerging markets underperformance could reverse in 2022 as monetary tightening in most of the emerging markets has already been well underway since last year. We have witnessed this reversal in the very beginning of 2022, with emerging markets outperforming developed markets and the Nasdaq index.
Emerging europe − strong despite geopolitical turbulence
The year was both busy and exciting in terms of investment opportunities for us at East Capital. Given our positive outlook for 2021, the strong market performance in Eastern Europe was not surprising. The region finished the year among the best performing in the emerging market universe, with a 15% gain. Notably, our investment team found mispriced assets and our Russia strategy had a particularly stellar year both in absolute and relative terms, delivering 10% alpha. Powered by an even higher number of company meetings and more efficient digital workflows, we were happy to see that the majority of the alpha earned by our off-index key active positions came from new ideas. These ideas were generated by our relentless efforts to stay local and engaged, do our own proprietary research, and react promptly to changing investment cases.
This was also a busy year in terms of IPOs. However, unlike 2020, due to high valuation expectations, only a handful of bourse debuts in 2021 had a positive post-IPO performance. It therefore paid off to be extremely selective and adjust quickly in the changing environment. We actively moved capital from long-term, high-growth tech stocks that had extremely successful 2020 performances, to financials, benefitting from the inflationary environment and higher interest rates.
When it comes to the Russian market, driven by high energy prices and lucrative cash yields, even greater highs could have been achieved were it not for the rising geopolitical uncertainty over the Ukraine conflict. While we can’t predict the outcome, we do believe that if we can come out of Q1 2022 with some sort of de-escalation, investors will return to looking at fundamentals, which point to an increasing upside for the Russian market, which is now trading at record-low multiples and record-high cash yields after a 30% de-rating. Valuations of the Russian market are now close to the 2014 trough, with P/E at ca 5x and the dividend yield at 11.6%.
Outlook for 2022
Looking ahead, we believe 2022 could be another good year for investors, with inflation starting to fall from Q2 2022, and the pandemic turning out to be manageable, given high vaccination rates and increased herd immunity after the Omicron variant. 2022 GDP growth is expected to be the highest in 38 years after 2021. Central banks are turning increasingly hawkish, and the markets have started to price in more monetary tightening, which should not come as a surprise. If this scenario materialises, then earnings growth should remain strong, paving the way to solid positive returns, with the global economy continuing to fire on all cylinders. We think equities will remain the preferred asset, given the backdrop of increasingly deep negative real rates and high inflation forcing investors to find protection, which equities do offer. This would set us up for an “alpha year,” where active investors like ourselves can focus on doing what we do best; finding high-quality companies trading at reasonable valuations.
Of course, the inflation pathway and its respective rates, alongside coronavirus mutations, remain key uncertainties. If inflation was to remain persistently high and central banks had to tighten policies more aggressively, this would have a negative impact on global markets, particularly as valuations remain stretched in the US. We will remain focused on fundamentals and building resilient portfolios that are robust against a wide range of top-down scenarios, while constantly reassessing our positioning based on market movements and macro developments.
Emerging markets are now trading with a hefty 35% discount compared to developed markets − the deepest discount in almost 15 years, reflecting the “peak pessimism” we believe is largely priced in.
The Chinese market is expected to stand out, with earnings growth of 15%, given increasing stock picking opportunities in sectors with lower government policy risks, especially those exposed to sustainability topics. Russia remains well supported by the strong commodities cycle and the strong outlook for oil prices, supported by a very tight demand/supply balance. Moreover, Russia provides unique exposure to the electric vehicle boom, producing high-grade nickel used in EV batteries.
While generally optimistic about our markets, we are under no illusion that 2022 is going to be a straightforward year in the markets. After all, no year ever is. We are confident that we will be able to navigate the markets. Read more in our outlook for emerging markets
The A.S.A.P year for ESG and sustainability
2021 was yet another year where we saw increased interest in ESG matters, as reflected by record inflows to sustainable funds. ESG assets now make up 11% of total global emerging market assets under management. This is up from just 3% three years ago, and is supported by a flurry of regulations with a long-lasting impact, such as the implementation of the Sustainable Finance Disclosure Regulation (SFDR) in Europe, and a series of policies and laws in China (double-reduction policy, anti-trust law, gaming restrictions, data privacy law), as well as major announcements by governments, corporates, and financial players regarding decarbonisation targets.
Our engagement activity with portfolio holdings around the world has remained at a high level, with environmental and social topics gaining momentum. In some countries, notably Russia, we have been involved in important discussions with authorities on the topic of climate change, which is encouraging. We introduced and rolled out a new tool to assess companies in terms of SDG Value Chain Analysis. Read more in our ESG outlook: “the A.S.A.P. year”, where we present four key areas that we think will shape the ESG and responsible investment space in the near future.
[1] MXWO Index; total return in USD
