As many countries around the world open up their economies, we need to reset some of our assumptions about EM trends. Despite a slow start, many EM vaccination programs have overtaken many developed countries thanks to a relatively low vaccine hesitancy. This puts EMs in a strong position for a consumer recovery. Here we look at some changes which will drive the opportunities in EM investing.
Opportunities after China's regulatory crackdown
2021 was a tough year for Chinese equities. China was the worst performing market last year, based on 67 MSCI country indices that we analysed, all measured in US Dollars. In the first half, stocks sold off on concerns over a barrage of new regulations from competition to employee and consumer protection. In the second half, domestic consumption was hit by the stringent zero-COVID-19 lockdowns; industrial production was affected by power cuts; property development was hit by regulatory constraints and bankruptcy; and infrastructure was dampened by a slowdown in government spending.
China was a decade behind much of the West in terms of regulation but five years ahead with eCommerce... it tried to catch up in a year
In November 2020, we spoke to competition economists and competition lawyers, and the consensus view appeared to be that China was a decade behind much of the West in terms of regulation but five years ahead with eCommerce. They expected China's regulatory approach to follow the EU's, in contrast to the US which is generally more hands off.
We believe what spooked most investors was China's determination to catch up in a single year. In August 2021 alone they finalised four new laws, the most significant of which was the Personal Information Protection Law (PIPL), China’s first privacy law, which went further than its European counterpart, GDPR.
The market factored in immediate-term negatives, but ignored the positives. Firstly, in fast-growing industries, removing barriers to entry and to competition can increase the size of the pie for all players. Secondly, increased competition encourages more efficient players, pushing costs and prices lower, and driving higher consumption levels. And thirdly, it promotes innovation.
We believe that levelling the playing field will create a regulated competitive framework for companies with strong brands to thrive. Some China franchises currently look attractive. For example, Alibaba finished the year down nearly 50%, and in December traded three standard deviations below its 5-year average Price/Earnings multiple. It ended the year at $118.79, a level last seen in May 2017, despite its revenue for the most recent quarter being 5.2 times that of the quarter just reported in May 2017.
EM central bank decoupling from the Fed
In 2021 we saw an unusual situation whereby emerging market central banks, which typically follow the Fed, raised interest rates to control inflation. For example, Banco Central do Brasil started raising rates in March 2021 when target Selic, the Brazilian federal funds rate, was at 2.0%. It ended the year at 9.25%.
LATAM interest rates could be close to their peak while the Fed is about to start raising
With the higher interest rates, funds flowed out of Latin American equities in 2021 and into fixed income, and some left the region altogether. Foreign institutional fund flows into South American markets helped strong performance in January, and if interest rates have peaked, these South American markets could provide a pleasant surprise to equity markets in 2022.
Despite an almost 400 bp increase in Brazil’s risk-free rate in 2021, see chart above, risk-adjusted equity returns are even more attractive today following sharp corrections towards the end of last year. These were driven by outflows from equities rather than earnings downgrades.
While US rates are expected to rise this year, many EMs are following their own path and could already be close to their interest rate peaks. With the 10-year bond in Brazil at 11.54%, there is talk of interest rates starting to come down as early as June, not least because the currency recovery seen in January could start removing some of the inflationary pressures.
Squid Game and the challenge for US cultural hegemony
Squid Game not only became a global TV phenomenon, but it also signals a fundamental cultural shift in attitudes.
China was the largest film market by far last year, with total revenues of $7.3bn, ahead of North America at $4.5bn. Meanwhile Hollywood’s foothold in China is rapidly eroding, with US movies accounting for only 12% of total sales in 2021, down from 30% in 2019.
The second highest-grossing film in 2021 after “Spider-Man: No Way Home”, was the Chinese film “The Battle at Lake Changjin” which made over $900m, becoming the highest grossing Chinese film in history.
We expect Hollywood’s relevance in EMs to continue to diminish
People tell us during our EM immersion studies that watching movies is high on their agenda, especially with family and friends. They like to watch Hollywood action movies for their special effects, but for other genres they prefer domestic movies where they can relate to the cultural aspects of dramas, and relate to jokes in comedies.
We expect Hollywood’s relevance in EMs to continue to diminish as budgets for domestic movies in EMs continue to grow, particularly as the US streaming giants fund more local productions.
Culture not science drives the world
Producing successful COVID-19 vaccines did not pave the way for a stronger belief in science. Vaccine hesitancy, like climate change scepticism, is part of people’s identities and interlinked with values and beliefs.
the pandemic made many reassess their values
However, the pandemic made many reassess their values. Encouragingly we are hearing from youths in emerging markets who describe that they see the pandemic as a wake-up call. They want to live in accordance with their values, and became more responsive, taking responsibility for protecting their families and communities. Mira, a 25-year-old graphic designer living in Mumbai, described the change to us as a "journey from apathy to empathy".
Companies should be aware that these consumers are looking to become more responsible citizens, with both environmental and social factors higher on their agendas.
The COVID women empowerment paradox
Many EMs households had been going through a silent revolution when it came to female empowerment. Household efficiency devices had been freeing up time and enabled women to earn their own money and thus increase their say in the household.
But during COVID we found that this progress stalled as women had to work from home and protect their families during lockdowns with little external help.
women found innovative ways keep their businesses alive and to continue to contribute to household income
Unsurprisingly, many women reported that they were “slaving away” giving up some of the independence they'd begun to enjoy before the pandemic. As unsung heroes of the pandemic, we are increasingly seeing changing attitudes, with more sharing of housework among family members. This will again leave women with more time to build their businesses after the pandemic.
During the pandemic, women found innovative ways keep their businesses alive and to continue to contribute to household income. New online platforms have sprung up to give them a digital distribution channel. Meesho.com is one such platform in India that allows entrepreneurs to establish online businesses in a one-stop online shop with zero set-up costs. We expect these platforms to play a bigger role as we emerge from the pandemic, and to be copied across other EMs.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of Trinetra Investment Management LLP and are subject to revision over time. Trinetra is authorised and regulated by the Financial Conduct Authority in the United Kingdom.