Looking ahead to what 2023 will bring for investors, Stockholm-based emerging market funds specialist East Capital has positioned itself for a period of “fat and flat” returns in the belief that 2022 has likely marked the end of a lucrative super cycle fuelled by ultra-low interest rates and abundant liquidity.
The next investment cycle will be shaped by heightened volatility and more modest real returns as central banks are set to withdraw 2.000 billion dollars in liquidity from the system in 2023, East Capital said in the 2023 outlook it presented this week. Yet, if the US can manage to achieve a soft landing and if China reopens, then emerging markets can offer attractive returns.
“If the US does achieve a broadly soft landing and China does open as we expect, the moderate rotation towards emerging markets we have started to see could well continue as investors focus on the attractive valuations and somewhat more positive macro backdrop offered in emerging markets, and particularly China, versus the US. ”
Cautious
East Capital’s chief investment officers - Peter Elam Håkansson as chairman and Jacob Grapengiesser as partner - noted several reasons for being cautious.
“Given that we have just experienced one of the strongest months ever for emerging markets, it feels odd to be writing a somewhat guarded outlook for 2023,” they said in their 2023 outlook. “However, the bleak global growth backdrop combined with high rates and monetary tightening make it difficult to be optimistic,”
Potential liquidity issues and an uncertain geopolitical environment will keep investors on the fence as they try to chart their course for next year. Hakansson and Grapengieser note that markets already have priced in this uncertainty to a large degree. “What will move the markets are the grey swans such as an unexpected peace settlement in Ukraine or a harder landing in the US,” their outlook said.
‘Fat and flat’
East Capital’s investment officers are “more confident” that 2022 has brought the end of a “spectacular equity bull run, that started with quantitative easing post the 2008 financial crisis”, and that now sees the beginning of a period of “fat and flat” returns, with wide trading ranges but with relatively low aggregate returns.
“In this environment, volatility will remain high (for example on China Covid-19 news) and returns will in general be less exciting. On a positive note, this is typically a good environment for stock pickers like us because valuations, company quality and fundamentals are what will really drive performance.”
Supercycles since 1900
East Capital has used the past year to reposition its portfolios for this era. “ We believe exposure to structural growth, the ability to defend margins and exceed consensus expectations combined with reasonable valuations will be the key drivers for company performance, and we have used the volatility (i.e. the “fat” part of the returns) to build stakes in phenomenal companies at highly attractive valuations. We intend to keep doing so.”
There Are Reasonable Alternatives
“For what investment liquidity that is available, equity markets will have to grapple with the new acronym in town; TINA becomes TARA, i.e. ”there is no alternative’ becomes ‘there are reasonable alternatives’.” Global bond yields are now higher than dividend yields for the first time in more than 10 years. This takes away a key argument that we have long been using regarding equity investing, East Capital said.
«One key conclusion we have from 2022 is that it has never been more difficult to consider emerging markets as one homogenous asset class,» East Capital said. «There is a very wide range of markets, each with their own individual drivers. One important aspect of this range of countries in general is that they are suffering less from the inflation and growth problems of developed markets. As a result, the GDP growth differential between developed and emerging markets will be the highest for quite a few years, something that supports the emerging markets case.»
Anatomy of global emerging markets
