Perspectives

After five consecutive quarterly declines, emerging market (EM) equities finally posted a relatively robust gain of 9.7% in the fourth quarter, which still left the asset class down -20.1% for the year. That compared to a fourth-quarter gain of 9.8% for the MSCI World Index, which left the developed markets (DM) benchmark down by -18.1% for the year. Both EM and DM equities were buffeted in 2022 by a few common factors, including surging global inflation, synchronized central bank tightening, and the major geopolitical shock of Russia’s invasion of Ukraine. However, despite broadly similar returns, the dynamics of EM and DM equities were quite distinct with the rise and fall of China’s zero-Covid policy playing a major role in EM.

Central banks maintained their hawkish tilt going into the new year, with the Fed and the European Central Bank (ECB) raising their policy rates respectively to 15-year and 13-year highs, while the Bank of Japan (BOJ) started to back away from its years-old Yield Curve Control policy. That said, some of the bounce in global equity values in the quarter appeared to be based on optimism that the Fed was getting close to pausing its rate-hiking cycle thanks to recent reports showing a moderation in inflation. Some European nations also began to report softer inflation, aided by a drop of nearly 50% in European natural gas prices in response to warmer weather and full gas storage tanks to cope with severely curtailed gas supplies from Russia.

China’s equity market experienced major gyrations in 2022. After falling -44% for the year through October, from that point China’s market rallied by 35% through the year end to finish the year with a decline of -21.9%. There were multiple factors behind the weakness through October, most notably the severe property market credit crunch and the economic stagnation due to the zero-Covid policy and rolling lockdowns. Capital flows to China also appear to have been dampened by China’s geopolitical embrace of the Russian pariah state and the drift to authoritarianism and heavy-handed state control under the supreme leader Xi Jinping. The key factor in the year-end reversal appears to have been the  government’s nearly complete abandonment of the zero-Covid policy, which sets the stage for a strong reopening recovery beginning as early as March or April.

EM Asia was the strongest performing EM region in the quarter, supported largely by a gain for MSCI China. South Korea, Thailand, Malaysia, and the Philippines also powered Asia with strong double-digit gains. India was a laggard with a gain of only 2% as monetary policy continued to tighten. The EM region of Europe, the Middle East, and Africa (EMEA) was the weakest performing region in the quarter, weighed down by declines in the Middle East markets in response to falling energy prices. Turkey was the standout performer in EMEA for the quarter and the year, with gains of 62.9% and 90.4%, respectively. The EM region of Latin America also had a disappointing quarter, despite a 12.5% gain in Mexico on optimism that inflation was peaking. Index-heavyweight Brazil was up only 2.3% as investors gave a tepid welcome to cabinet appointments by incoming President Lula. On net, EM Latin America rose by 5.7% in the quarter, which still left it as the best-performing EM region for the year with a gain of 8.9%.

All major EM sectors posted gains in the fourth quarter. The EM Growth and Value Indexes recorded identical gains of 9.7% in the quarter, although for the year-to-date period, EM Growth declined by -23.8%, while EM Value declined by a more modest -15.6%. It is too early to tell whether the positive turn in EM equities in the fourth quarter was a decisive break to the upside. But history shows that EM has troughed ahead of the S&P 500 in four of the 10 prior bear markets and on the same date as the S&P 500 on three occasions. Although global central bank tightening still provides potential headwinds to global equity markets, the prospect of sustained Asia and EM outperformance appears to be the highest in years based on attractive valuations and exceptional earnings prospects. Indeed, China’s decisive about-face on Covid suppression and its clear pivot toward generating consumption-led growth highlight the very different cyclical positions of the main EM nation compared to key DM nations which are still focused on fighting inflation.