Foreign investors in retreat mode across most emerging markets

Analysts at Morgan Stanley see EM equities 'struggling' in 2022 as they battle gradual tightening of global and local monetary conditions and several other idiosyncratic headwinds

Foreign institutional investors (FIIs) have been in retreat mode across emerging markets (EMs). Over the past 12 months (since October 2020), they have withdrawn money from most EMs, including Taiwan, South Africa, Thailand, Malaysia, Philippines and South Korea, data shows. India, Indonesia and Brazil, however, have been an exception where the net FII flow has been still in the positive zone during this period, shows data.

“Covid-19 crisis seems to be on the wane. Interest rates are not going to go down anymore and liquidity (in EMs) is not going to get any better. Markets will eventually come back to judging companies based on earnings growth, and the current valuations do not justify the earnings growth potential. If interest rates in the US rise, money will move out from the EMs. 2022 will see a big economic recovery across most countries,” explains Jigar Shah, chief executive officer, Kimeng Securities India.

Click here for a table on FII flows across EMs

Those at Morgan Stanley, too, see EM equities ‘struggling’ in 2022 as they battle gradual tightening of global and local monetary conditions and several other idiosyncratic headwinds. Both Korea and Taiwan, according to them, face negative cyclical dynamics in the semis and tech hardware spaces as the work from home (WFH)-boom ebbs alongside an unprecedented investment cycle. 

Though the global research and brokerage house sees the S&P BSE Sensex at 70,000 mark (base case) by December-2022 end, it has downgraded Indian equities to equal-weight in their global emerging markets (GEMs) country portfolio.

“Brazil faces a challenging macro environment as well as the run-up to a highly contested presidential election, although valuations have adjusted and we remain EW. These four markets account for 65 per cent of MSCI EM by market capitalisation, constraining the headline index outlook,” wrote analysts at Morgan Stanley in a recent report led by Jonathan F Garner, their chief Asia and emerging market strategist.

Meanwhile, the MSCI EM index has underperformed in the last one year (since October 2020) with a gain of around 5 per cent as compared to 27 per cent rally in the MSCI World index. Even on a year-to-date (YTD) basis, the MSCI EM index has slipped around 2 per cent as against nearly 20 per cent rise in the MSCI World index, data show. CLICK HERE FOR THE TABLE

As regards India, Shah of Kimeng Securities India feels India will still be able to attract flows in 2022 as China’s attraction has reduced over time. “In the last few weeks, India has also borne the brunt of FII selling in the equity segment. Rising inflation is also a concern, especially for India. Inflation adjustment will also reflect in currency at some point in time. That said, from a micro perspective, India will remain attractive as there are individual stories – whether in e-commerce, renewables space, consumer and healthcare – that will play out and continue to attract foreign capital,” he said.

Given this backdrop, analysts at Prabhudas Lilladher expect the Indian markets to remain choppy over the next few months as they digest global and domestic developments amid rich valuations. Banks, Capital Goods and Auto present best risk-reward in current market context, they said.

“So far, markets have been saved by huge fund inflow from retail/HNI investors. However, sharp volatility looks likely given sustained FII selling of Rs 164 billion in the last six weeks. Although we remain structurally positive on the Indian markets and economy, we do not rule out near-term hiccups given stretched valuations, commodity prices and its likely impact on inflation and demand, too much froth in the primary market and the impact of global funds flow given likelihood of change in global monetary policy stance,” said a recent note from the domestic brokerage.