Outlook 2022: Asian Equities – China: a different stage in the cycle

 Key points

• 2021 has been a difficult year to navigate due to a series of various challenges, including heightened regulation, component shortages, COVID lockdowns, and logistic disruptions.
• China is reforming for longer-term prosperity, although this has resulted in some near-term headwind.
• However, China’s equities market could potentially benefit from it being at a different stage in the interest rate cycle relative to much of the rest of the world, with greater scope to ease.
• The Asian region as a whole is generally in a much better fiscal position to withstand U.S. tapering and rate hike.

Following a strong year in 2020, Asian equity markets have faced a more challenging environment in 2021 as investor sentiment has been impacted by a series of macro factors, including the spread of the Covid-19 Delta variant, regulatory changes in China, global supply chain challenges and monetary policy tightening risks from major central banks. Contrary to Europe and the US, most Asian countries were still prone to various degrees of lockdown throughout the year, which has constrained production and resulted in a more disjointed economic recovery. In addition, exporters and manufacturers have been hit by rising raw material costs, logistic disruptions, and component shortages, further weighing on the recovery. However, more recent easing of restrictions in many of the key export-dependent economies – such as Korea, Singapore and Taiwan – should ensure that these supply constraints will only be short term in nature whilst demand has continued to remain strong.  This provides the framework for a steadier start for Asian equities into 2022.

China in focus: a different story unveiling

Specifically, in relation to the China market, there are grounds for a more constructive view overall for the new year after the various travails of 2021. Given the bias towards tightening that has been in place over the last few years, the economy looks to be at a different stage of the cycle relative to most other major markets, which provides the potential for the market to outperform in the coming year. Although many countries within the emerging markets universe, such as Korea, Russia and Brazil, have begun to increase interest rates in recent months and the US to start tapering its bond purchase programme, China’s more conventional monetary and fiscal policy has put it in a different stage of the cycle. In contrast to the monetary loosening seen across the world in 2020, China has essentially kept interest rates flat over this period and only nominally reduced the reserve ratio requirement in July as a specific measure to provide liquidity support to smaller businesses.  Accordingly, the PBOC has significant scope to ease monetary policy to help counter any further slowdown in the economy, in contrast to what is likely to be a tightening environment in much of the rest of the world. 

Credit policies will also likely be relaxed to help offset the weakness in the property sector, albeit the long-term strategic goal to reform the industry will remain in place. Any such policy easing in 2022 should service to support both fixed asset investment and consumer spending, the two key domestic pillars of the country’s dual-circulation economic model. 

Private sectors in China: the sun will shine again?

Regulatory changes across a range of sectors - including technology, education, and gaming - have also negatively impacted investor sentiment for Chinese equities. Many of the affected industries saw large corrections as a result in 2021. Although the motivations behind these changes remain debatable among some foreign investors, the private sector remains critical to China’s growth and it seems unlikely that the government’s intention has been to deliberately undermine this vital part of the economy. Instead it appears that the goal of the Chinese government has been to more closely align the private sector with the government’s longer term political, social, and economic objectives (encapsulated within the ‘common prosperity’ policy).   At the same time, it is clear that the regulator has struggled to keep pace with developments in many of the newer sectors of the economy, especially those involving the internet in some capacity. Many of the recent regulatory initiatives appear to be intended to address this; it is also worth observing that the challenges around monopoly behaviour by big tech – as well as income inequality - are also being examined in other parts of the world, and are not unique to China.

China has significantly underperformed the rest of the world in 2021, breaking its long-term trend of relative outperformance.

Exhibit: Relative performance of MSCI China index vs World index

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Source: Bloomberg, as of 11/30/2021

Whilst the regulatory changes this time have been more sweeping than what has been seen previously, in many cases they should create a clearer framework in the longer run for investors. Nevertheless, one outcome is that it reinforces the need for an active investing approach in order to determine who are the winners and losers from all of these regulatory changes; for example, it is clear that some business models are unlikely to be viable in the new environment. Approaching the end of 2021, it is probable that the peak of regulatory change has been seen, and thus investors will start to re-evaluate the outlook for those companies affected by these measures, especially as valuations have reflected much of the uncertainty.

Overall, therefore there are enough reasons to hold a more constructive view of China into 2022 after what has been a difficult year, both in absolute terms and relative to other parts of the world, including the wider emerging markets universe. 

Export-led Asian economies look to continue benefiting from strong demands amid policy risks

Elsewhere in Asia, the big export markets of Korea and Taiwan have enjoyed a good year in 2021 reflecting the strength in demand from the rest of the world has recovery from Covid-19 has taken hold.  Taiwan has been a particular beneficiary given the importance of the technology sector to its economy. While the cycle does look extended, so far it appears to be intact, reflecting the much greater ubiquity of technology in many aspects of daily life compared to previously. This supports our positive outlook for many of the leading technology names across the region.

On the policy front, memories of the 2013 ‘taper tantrum’ remain fresh for many Asian investors. As of the writing of this paper, the US Federal Reserve appears about to embark on a tapering of its current programme, and this could represent a potential challenge to several ASEAN markets. However, these economies are generally in a much stronger position compared to 2013 so a repeat looks unlikely, albeit that a rising rate environment will likely pose a headwind going into 2021. 

The same issue is likely to be true of the Indian market – an outperformer this year, despite suffering a serious Covid-19 outbreak in the first half.  Unlike much of the rest of the region, inflation is high and has been rising, and this may limit the ability of the central bank to provide support in the event of any slowdown in the economy.