Will emerging markets have a better 2022, or is it downhill from here?

Emerging market equities had a dismal year in 2021. John Stepek asks if 2022 will be any better, and takes a look at some of the most promising areas for investors.

Today I want to turn to a topic I actually haven't really discussed a great deal this year – emerging markets.

Emerging markets have had a "dismal year", as one headline from Capital Economics puts it. In dollar terms, the MSCI World Index of developed-world equities is up around 17%. The equivalent index of emerging-market equities is down 6%.

The picture is more complicated than that, which we'll get to in a moment. But the question remains – will 2022 be a turnaround year for emerging markets? Or will things get worse?

What really matters when investing in emerging markets

Valuations are very important when it comes to investing. If you buy cheap, you should make money in the long run. If you buy expensive, you shouldn't expect to make good returns (the trick of course, is in defining "cheap" and "expensive", particularly at a time when the latter has been doing so much better than the former on many measures – but we'll return to that another day).

Anyway, when it comes to investing in emerging or frontier markets, there's something even more important than valuations. Indeed, Eoin Treacy of FullerTreacyMoney.com always makes the point that "governance is everything".

You couldn't hope for a more vivid illustration of this than what's happened to Turkey in the last few weeks. The currency had been collapsing at an incredible rate, and the slide was only arrested when President Recep Tayyip Erdogan promised to sort things out with a slightly complicated but not entirely delusional scheme, which rather pulled the rug out from under the shorts.

Now, you may or may not believe that Erdogan can get a handle on this (remember that this is far from being Turkey's first currency crisis), but whatever your view is right now, no one wants to be invested in a country while its currency is undergoing a 50% drop against the US dollar.

Particularly as none of this is necessary. Turkey should and could be a much stronger economy given its many attractions (a young population, strategic location, spectacular tourist destination, etc).

I'm not going to make any more jibes about Erdogan's "unorthodox" views on how interest rates and inflation relate because I'm not sure our own views are that much closer to reality.

However, beneath all of that, the fundamental problem in Turkey is that Erdogan is authoritarian and mercurial, and anyone with any sense knows that this is not a good environment in which to test the strength of one's property rights, particularly if you're a foreign investor.

When you look at it in this light – that the appeal of any market, but developing ones in particular, has to start with the strength of property rights – then you can start to see why emerging markets (as a group) have had a miserable year.

It's because the perception of property rights has deteriorated dramatically in the biggest emerging market of them all, China. China decided this year that it's time to show business who's boss. Listings of Chinese companies overseas are suddenly in grave doubt, and anyone who gets mouthy about the party won't be tolerated anymore.

On top of that, the authorities have been trying (and succeeding – maybe too well) to pop the Chinese property bubble. As a result, the MSCI China index is down more than 20% in the year to date.

Which areas have the most promise for 2022 and beyond?

However, given that China is such a big weight in the index, that's rather obscured the fact that lots of other emerging markets have actually done pretty well this year. For example, Taiwan and Thailand have both seen strong returns, while Vietnam – one of our frontier favourites, so not actually in the MSCI emerging market index – saw an absolutely stellar 33% return.

I'd certainly hang onto Vietnam if you own it, though I wouldn't necessarily expect those sorts of returns in 2022, and it's also worth noting that any ongoing slowdown in China next year could be tricky (equally though, if China takes the reins off to offset its weakening property sector, maybe that won't be such an issue).

What of other areas? India had an excellent year too, with the Sensex index up more than 20%. India is almost always expensive but that's arguably because it's the emerging market deemed to have the strongest long-term prospects and also a relatively healthy attitude towards property rights (note the use of the word "relatively").

Eastern Europe – I have a soft spot for eastern Europe excluding Russia – there are a lot of interesting markets there and countries with a great deal of potential, Poland in particular. I'd just skip Russia (Merryn and I debate this all the time – and there are certainly good and bad times to hold Russian stocks – but I just don't want the hassle of owning stocks in a market where I'm being tolerated rather than welcomed).

Latin America had a rough year, even although commodity prices have been generally high. Again, that's partly down to tricky politics (for example, Chile just elected its youngest president ever, a left-winger who is keen to rework the country's private pensions system among other things).

That said, if you think that commodity reflation might be here to stay during 2022, then as Max King, MoneyWeek regular, told this year's roundtable, Latin America could well be worth a punt. (If you missed the roundtable, make sure you subscribe to MoneyWeek magazine – you can get your first six issues free by clicking here).

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