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2022: Dispersion in Asian equity valuations provide scope to lean into risk

By William Lam and Ian Hargreaves, Co-Heads of Invesco’s Asian & Emerging Markets Equity team.

Asian and emerging market equity markets have struggled for much of 2021, with exports growth slowing after a strong recovery and China-related concerns denting investor sentiment. The slow rollout of vaccination programmes in many emerging markets has slowed the recovery, particularly as new Covid variants emerged. Yet, conditions have started to normalise, and looking forward we find reasons to be optimistic.

Valuation discrepancies between and within markets and sectors remain wide, with scope to lean into areas of excessive pessimism, while avoiding frothy areas of the market. We are wary of investment narratives, which rely on a cyclical recovery being extrapolated too far forward, as we saw with some of last year’s Covid-beneficiaries and China.

Exuberance towards China has given way to disappointment and pessimism, and a much more favourable risk premium is now being offered to investors as we enter 2022. Meanwhile, South East Asian and non-Asian emerging markets have been relatively weak, which we feel underappreciates their re-opening potential.

Grounds for optimism

Returns from Asian and emerging equity markets have been less impressive this year than last, which is unsurprising given how strongly valuations rebounded from their lows, reaching levels they have struggled to maintain historically. However, we do not believe that this is the end of the cycle, more a time correction as earnings and growth of book value catch-up.

Markets are pricing in a continued improvement in earnings, which feels logical to us given that the recovery from the Covid-pandemic is still at a tentative stage in some parts of world, with a tailwind from stimulus measures and relatively low inventories on a global basis. The financial system is also in a much better place than investors initially feared, a marked difference to the backdrop in the recovery from the GFC.

However, it is reasonable to expect a more gradual uptrend in earnings from here, still positive but with the rate of change likely to have peaked. On one hand, supply chain disruptions remain a feature of the post-Covid backdrop, with unmet demand spilling well into 2022. On the other, inflationary pressures are likely to depress the operating margins of price takers. As markets digest these complexities and potential policy changes, there is much scope for active stock pickers to capitalise on misunderstood, idiosyncratic opportunities, especially given that valuation discrepancies within markets and sectors remain wide.

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