We are more optimistic about the investment outlook for China in 2022, especially relative to other emerging and developed markets. The country’s economic growth is being driven by both the policy and liquidity cycles, and we believe that monetary tightening has peaked. As such, we expect to see improvements in liquidity conditions.

Key points

  1. China may outperform other markets in 2022 given its easing cycle has already started, valuations are more reasonable, and there is still low ownership among global investors.
  2. Value investing may continue to outperform the market’s growth element next year, as it provides a good hedge against inflation.
  3. Investors are avoiding sectors that have been impacted by regulatory changes, such as the internet and education, and rotating into areas perceived to be less impacted, such as healthcare, sportswear, and renewables.
  4. We have identified interesting opportunities in the healthcare, retail, and media sectors.

What is your investment outlook in 2022?

We are more optimistic about the investment outlook for China in 2022, especially relative to other emerging and developed markets. The country’s economic growth is being driven by both the policy and liquidity cycles, and we believe that monetary tightening has peaked. As such, we expect to see improvements in liquidity conditions.

China will see leadership changes in 2022, especially at the local and ministerial levels, and more accommodative fiscal policies usually go hand in hand with such moves. With the rest of the world edging towards more hawkish monetary conditions after two years of excessive easing, China should enter the year in a very different cycle relative to other markets. Although there is still downside risk regarding consensus earnings expectations, we believe the country is likely to outperform emerging markets in 2022, given the start of its easing cycle, more reasonable valuations, and low ownership among global investors.   

What do you think could surprise the market in 2022, either positively or negatively?

This year, the portfolio’s value strategy has outperformed the growth element, and investors attribute this to rising inflation. We believe that the inflation witnessed in 2021 is not transitory, given it is underpinned by many structural drivers. As a result, value investing may continue to outperform growth next year, as value sectors provide good inflation hedges. Value’s outperformance relative to growth is driven by solid earnings revisions rather than multiple changes, and valuations remain depressed even after the strong performance of 2021.

There is also a downside risk looming in 2022, as those equity markets with high retail participation look vulnerable to elevated valuations and volatile retail trading sentiment.

Which themes, sectors, or regions offer opportunities or potential risks?

We remain positive on opportunities in the energy and financials sectors.  In 2022, we expect to see companies raise prices to deal with rising producer inflation. But there will be beneficiaries, too, as we transition towards consumer price inflation.

Within your portfolio, where do you have the highest levels of conviction, and which areas are you avoiding?

Both ‘new’ and ‘old China’ companies offer interesting opportunities. For many traditional sectors, like energy and materials, investors still believe that the cyclical upturn is driving earnings improvements. But, a lack of new investment is structural, and average profitability over the next five years will be significantly higher than we’ve seen over the past decade. Many new-economy sectors have been negatively impacted by regulation and weak consumption, and, as such, there are stock opportunities emerging in healthcare, retail, media, and gas operators.

It’s difficult to predict the future direction of policy changes but avoiding stocks and sectors where valuations are full and investors’ expectations are high can help mitigate the current uncertainty. Also, companies with longer track records and experienced management teams might see a way through this period, and optimise their business models to accommodate any new regulations.

Investors are exiting sectors that have been impacted by policy changes, such as the internet and education, and rotating into areas perceived to be less impacted, such as healthcare, sportswear, and renewables. As a result, these sectors’ overall valuation premium versus the market has moved to an extreme level. We believe any uncertainty (policy related or otherwise) or a deterioration in fundamentals will likely result in a dramatic de-rating.

Do you expect sustainability factors to influence returns, and how is this reflected in your portfolios?

Sustainability factors are likely to drive rising inflation over the medium term. The transition to a ‘green economy’ is not reversible and could raise the cost of living for many people. How governments, corporates, and consumers cope with this change remains uncertain, but, given the environment, we are positioning the portfolio to benefit from this trend.  Additionally, we are committed to our belief that future changes in the portfolio will lead to a better overall environmental, social, and governance (ESG) rating for the Fund.

Originally published by Jing Ning, Portfolio Manager – Fidelity China Fund, Fidelity