Our cautious outlook on EM equities in 2021 has been rewarded – the index is now trading at 17-year lows versus DM equities as it struggles to generate any meaningful EPS growth (0% CAGR post-2010). EM valuation is cheaper in absolute and relative terms, as forward P/E fell from over 16x at the peak in January to below 13x now, but remains at 68th percentile of 5-year range and far from being outright cheap. We expect EM equities in aggregate to continue to struggle next year, with only 3% upside to our December 2022 target.

We stay more constructive on Japan equities, with 12% upside to our TOPIX target of 2250, helped by an above-consensus recovery/reopening outlook and ongoing support for operating margins from resilient investment and DM-led global growth and a competitive JPY. Although Japan has underperformed the US and Europe significantly this year, it has outperformed EM by 467bp YTD (as of Nov 9th). We think that in 2022 Japan will once again continue its long-run outperformance of EM over the cycle, which dates back to Jan 2013 and is driven by superior EPS growth over the cycle on ROE convergence. Collectively, our Cross-Asset Strategy and global equity strategy team recommends an OW position on Europe and Japan equities, versus neutral on EM and UW on US equities (see 2022 Global Strategy Outlook: The Training Wheels Come Off).

We think it is too soon to turn more constructive on China and see limited upside at the index level despite this year’s significant underperformance. Valuations are not sufficiently cheap to history or overall EM to combat the further downward move in earnings estimates which we expect over the winter due to elevated PPI inflation, power shortages, Covid resurgence and further slowdown in property activity. Meanwhile, this year’s regulatory reset is still leading to a medium to longer term re-assessment of business models and profitability for key sectors such as Internet and E-commerce. We continue to prefer A-shares vs. the offshore China space, given supportive measures that could encourage long-term sustainable institutional participation and their better positioned opportunity set under the new regulatory framework.

As in 2021, the opportunity in Asia/EM arises at the individual market and sub-regional level as well as in stock selection. We see a structural breakout potential for EEMEA as energy prices find support from more decarbonisation pressure on fossil fuel supply than demand in the short-medium term, as well as for stronger economic pass-through into domestic economies. We also prefer ASEAN (OW Indonesia and Singapore) for reopening/recovery over North Asia, which may see some reversion in the semis/ hardware cycle in particular. Our Focus Lists have generated substantial outperformance over the last year and since inception – we make several changes today, adding SK Innovation and GoerTek to our APxJ and GEM Lists, Santos (to APxJ) and Saudi National Bank (to GEM).