Shake it off: Recovery expected, but risks remain

Against a backdrop of the ongoing pandemic, tighter regulation in China, and the prospect of reduced policy support from global central banks, 2021 has not been without its risks. However, as we look to the new year, we see opportunities for careful, bottom-up stock pickers in a wide range of industries across Asia. Fidelity’s Matthew Quaife, Head of Multi Asset Investment, Asia; Casey McLean, Director of Equities; and Marty Dropkin, Head of Asian Fixed Income, gather their thoughts on what lies ahead in 2022.

Key points:

• Inflation should persist in 2022
• Undervalued sectors and businesses will attract investor attention
• Sustainable investing will move even closer to centre stage
• Deep research of a company’s ethical characteristics will become even more crucial
• How ESG considerations affect asset values remains to be seen
• The pandemic will stay in focus, but we will see greater re-opening momentum
• Tighter monetary policy will be less keenly felt in China and Asia

Inflation: persistent or transitory?

A more persistent inflationary environment is expected in 2022, but this should not threaten central  bank policy and the prospect of further tightening in China is seen as relatively small.

“Although we will receive signals that it does not plan to let inflation rise too sharply, the People’s Bank of China is willing to let prices rise a little to inflate away some of the debt in the economy and keep growth rolling,” says Quaife. “There’s a crucial difference between relatively controlled central bank assistance and chasing runaway inflation,” he continues.

For investors, this unwraps opportunities in companies and sectors that are undervalued, “I am definitely on the optimistic side,” notes McLean. Specifically, he points to technology names listed in Hong Kong versus the US, some of which have halved in value but still possess strong growth outlooks. “There are also smaller companies in China with an ability to adapt and grow within an expanding economy,” he continues. Companies at the early stages of their innovation journey are in focus, given they display the most attractive growth rates.

The integration of sustainability factors

In the coming months, environmental, social, and governance (ESG) considerations will move to an even more central point of the investment stage. And when considering sustainability, it is becoming ever more apparent that integration is the best strategy when thinking about portfolio construction.

“At Fidelity, we have 200 analysts who constantly engage with investee companies,” observes Dropkin. “But it’s not just a case of liaising with these businesses to assess the here and now. Instead, it’s far more to do with monitoring how they will evolve,” he adds.

For example, deep and incisive research is increasingly crucial within the fixed income market. This year has witnessed considerable green bond issuance, especially in China. Yet, a lack of standardisation within the market remains a challenge for investors.  “That’s why our research team needs to reach into the heart of a company to ensure it genuinely adheres to the ESG principles that we would define as appropriate,” says Dropkin.

For the equity market, focus will be on segments likely to grow over the longer term.

Quaife singles out the electric vehicle (EV) sector, as an example of an industry that is expected to expand rapidly. Although household names like Tesla are adept at grabbing the headlines, he points out that the true value of the EV theme begins to materialise “as we move further down the supply chain.” What’s more, many of these businesses are based in Asia.  “EV-related firms are deeply embedded in a supply chain that can drive a great deal of growth over the next decade,” continues Quaife.

Sustainability and its impact on asset returns

The positive momentum of sustainability-related factors is no passing trend and should be considered when allocating across sectors. This is notably relevant for China in terms of fixed income, although the so-called ‘greenium’ – the premium at which a green bond trades versus a conventional bond – has yet to emerge there.  “There could be an opportunity to add green bonds to portfolios, where they’re trading on an equivalent basis to bonds of other colours,” says Dropkin.

The same dynamic exists in equity markets. “The most sustainable companies are trading at premiums to the least sustainable,” explains McLean. And although emerging markets have covered less ethical distance than developed markets, progress is being made, and this trend is likely to continue.

Moving on from COVID

The pandemic won’t necessarily go away in 2022, but its effects might not be as acute as those experienced in the past two years. In economic terms, supply chain dynamics will remain tight for some time yet, contributing to inflationary pressures. Therefore, investors are likely to remain cautious, particularly in the first quarter of 2022, given COVID variants remain a spectre. In turn, we could see further lockdowns leading to what Dropkin describes as “a wobble” at the start of the new year.

Yet, it’s not all bad news, as there is a dichotomy between Asia and the rest of the world. There are investment opportunities among countries that have had a more challenging pandemic but are now opening up. “In sectoral terms, we certainly see interesting developments in, for example, China biotech,” says Dropkin, pointing to high-end pharmaceutical manufacturing organisations.

The prospect of central bank tightening

Throughout COVID-19, central banks implemented what might now be described as excessive supportive measures, much of which found their way into the stock markets. Correspondingly, any policy changes are less likely to impact China and Asia than the US for the simple reason that fiscal stimulus has been much lighter in the former.

“For instance, we have recently looked at flow statistics into retail-dominated exchange-traded funds,” says McLean. “And while flows have continued, they haven’t been abnormal. It’s true that some innovative companies with long-duration secular growth have sold off, but they will become buying opportunities once regulatory risks dissipate,” concludes McLean.