Morgan Stanley sees emerging markets struggle in 2022 amid rich valuation

After downgrading Indian equities recently given their rich valuations, Morgan Stanley sees emerging markets (EMs) ‘struggling’ for returns in calendar year 2022 (CY22) amid rich valuations. Despite downgrading India, the global research and brokerage house remains ‘structurally bullish’ on Indian equities and is looking for stock-level opportunities to hold exposure. Among sectors, it has maintained an overweight stance on the consumer discretionary space.

At the broader level, however, the only exception is Japan where they see expect a double-digit return of 12 per cent (TOPIX target of 2250) in CY22. Among the other regions, Morgan Stanley maintains an overweight position on European and Japanese equities, remains neutral on EMs and underweight on US equities.

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“EM valuation is cheaper in absolute and relative terms, as forward price/earnings (P/E) fell from over 16x at the peak in January to below 13x now, but remains at 68th percentile of five-year range and far from being outright cheap. We expect EM equities in aggregate to continue to struggle next year, with only 3 per cent upside to our December 2022 target,” wrote analysts at Morgan Stanley in a recent report led by Jonathan F Garner, their chief Asia and emerging market strategist.

Stock selection key

2022, Morgan Stanley said, will be all about stock selection rather than chasing broad market-wide returns. “As in 2021, the opportunity in Asia/EM arises at the individual market and sub-regional level as well as in stock selection. We remain cautious on China equities going into 2022. Valuations are not sufficiently cheap to history or overall EM to combat the further downward move in earnings estimates,” Morgan Stanley said. INDEX-WISE RETURN EXPECTATION

Among sectors, they remain underweight on semiconductors (expressed primarily through Taiwan IT) and China Internet (reflected in the Communication Services GICS sector). Utilities sector is their key underweight, as the brokerage remains cognisant of the elevated regulatory risk (and potential support mechanisms) through the decarbonisation process.

Economic growth

Given the level of vaccination, easing of restrictions and the pent-up demand will lift the overall economic growth rate in the Asian region and pegs the rate of growth at 5.4 per cent in 2022 versus consensus of 5 per cent). 

As regards India, Morgan Stanley sees economic growth as measured by the country’s gross domestic product (GDP) at 7.5 per cent as compared to a consensus forecast of 6.8 per cent.

“We see this recovery extending beyond North Asian economies to the rest of the region, led by India and ASEAN,” Morgan Stanley said.

Against the backdrop of a more broad-based recovery in the region, Morgan Stanley expects Asian inflation to pick up moderately in 2022, to 2.3 per cent (vs. 1.7 per cent in 2021) and sees inflation in India average at 5 per cent in 2022. The Reserve Bank of India (RBI), it believes can hike rates in 2022 and sees the repo rate at 5.5 per cent in the fourth quarter of 2022 (Q4-2022).