Emerging market (EM) equities capped off a disappointing year with the MSCI EM Index declining -1.3% for the quarter and -2.5% for the year. In comparison, the MSCI World Index of developed market (DM) equities gained 7.8% for the quarter and 21.8% for the year. Last year marked the most pronounced annual underperformance of EM equities versus DM equities since the “taper-tantrum” year of 2013. EM’s fourth-quarter underperformance reflected some of the same factors that hindered its full-year performance, including China’s ongoing market and economic malaise, global supply-chain stresses associated with the pandemic, the Fed’s increasingly hawkish posture, elevated energy prices, and a spree of rate hikes by EM central banks.
With MSCI China representing about one-third of the MSCI EM Index, its recent weakness has masked decent performance of other EM equity markets. For example, in the quarter, MSCI EM ex-China was up 1.1% while China posted a loss of -6.1%. For 2021 overall, MSCI EM ex-China posted a gain of 10.0%, while China posted a loss of -21.7%. Headwinds for Chinese equities in recent quarters have included multiple regulatory clampdowns associated with President Xi’s “common prosperity” program, a severe property market credit crunch, and disappointing economic performance associated with rolling COVID-19 lockdowns and production cutbacks.
EM’s modest decline in the quarter was associated with widespread weakness across sectors. Only two EM sectors, Information Technology and Utilities, posted positive performance for the quarter, with gains of 7.4% and 0.7% respectively. The weakest EM sectors in the quarter were Consumer Discretionary, Real Estate, and Health Care, with respective losses of -8.2%, -8.5%, and -15.3%. On a full-year basis, the MSCI EM Index’s modest loss of -2.5% masked a wide dispersion of sector performance. Energy, Utilities, and Information Technology posted double-digit gains for the year, while Health Care, Real Estate, and Consumer Discretionary posted double-digit losses. The large Consumer Discretionary sector was notably weak, with a loss of -29.1% for the year reflecting China’s regulatory clampdown and more general EM margin pressures associated with higher energy and other input prices.
As is often the case in EM, there was a wide dispersion of returns among countries and regions in both the quarter and year overall. In the quarter, the Czech Republic, Egypt, Peru, and the United Arab Emirates posted double-digit gains, while Chile and Turkey posted double-digit declines. For 2021 overall, the Czech Republic, the United Arab Emirates, and Saudi Arabia posted gains exceeding 40%, while other standout performers were Argentina, India, Mexico, and Taiwan, with gains in the 20-30% range. In contrast, China, Pakistan, and Turkey posted full-year losses exceeding -20%. For the year, regional returns were also widely dispersed with the EM region of Europe, the Middle East, and Africa (EMEA) posting a gain of 23.9% while EM Asia and EM Latin America posted declines of -5.1% and -8.1%, respectively. The notable full-year performance of the EMEA region reflected improved prospects for energy-exporting nations in a year when the price of Brent crude oil rose by 53%.
Looking back, EM nations clearly participated in the global economic recovery in 2021, with Bloomberg’s estimates of 12-month for-ward profits rising by 45.5% over the course of the year. However, the MSCI EM Index failed to participate in the global equity rally because the forward P/E multiple fell sharply from 19.0x to 12.4x over the same period. With the benefit of hindsight, China’s regulatory clampdown and a spree of rate hikes by EM central banks outside of China seemed to be the main factors depressing EM valuation multiples in 2021.
With the MSCI EM Index now trading at a modest forward multiple of 11.9x and with analysts projecting EPS growth of 17% for 2022 and 10% for 2023, the outlook for EM equities looks reasonably constructive. It is encouraging that Chinese policymakers have pivoted toward more growth-friendly policy in recent weeks and that the worst of the regulatory clampdown appears to be in the rear-view mirror. To be sure, risks remain including prospects for Fed tightening and those associated with the rise of the Omicron variant. On the positive side, these risks seem well discounted in last year’s EM multiple contraction, while any positive developments like an early peaking of the Omicron wave or more constructive regulatory news from China could help EM equity valuation multiples stabilize or even improve in the year ahead.