Stocks that are positioned to tap into innovation, digital and other longer-term themes should look attractive to investors in search of reliable returns.
EM equities in certain sectors and geographies – especially China and India – are particularly well-placed to meet this need, according to PGIM.
“In the EM equities portfolios, we have continued to build positions in the Chinese market from the turn of the year, having been very underweight during 2021,” said Raj Shant, managing director and portfolio specialist at Jennison Associates, a PGIM business.
The firm is also positive on the Indian market over the longer term. This is based on the country’s demographic drivers and digital transformation promise to be tailwinds over the coming year.
Such a bright outlook includes taking a selective approach in the fintech space in EM. Here, PGIM believes incumbent legacy banks have been inefficient, expensive and slow to embrace the newer and cheaper ways to reach and service customers.
In Shant’s view, this leaves more profitable opportunities than in more developed markets where the banks have moved more swiftly to offer digital services.
In addition, in China, the firm has been adding companies it expects will be the growth leaders over the coming years, rather than the tech giants that led the market in the last decade.
“We believe the EV-related sectors in China are particularly attractive as we face prolonged secular growth in this sector, combined with EV battery shortages globally,” added Shant.
Constructive on China
This renewed confidence in key parts of the Chinese economy follow the firm’s relatively early move to turn more wary of the domestic equity market at the end of 2020 and throughout last year.
However, the notable under-performance of China equities in 2021 has led to a sharper focus now.
“The Chinese Communist Party’s 20th Party Congress takes place this autumn and the government has made it clear that the focus is shifting towards greater stability and more market-friendly policies in the run-up to that,” Shant explained.
At the same time, given the reliance this perspective requires on government policies and the ability to define the intentions of China’s leaders, investors should instead look for companies with robust growth potential.
Shant says these are reflected by products and services aligned with the government’s strategic priorities.
Gearing up for growth
Meanwhile, the rotation by investors out of growth coupled with compressed multiples for the highest growth companies have led to valuations of growth stocks returning to levels in early 2019.
Based on the last four interest rate cycles in the past three decades, Shant says growth equities tend to under-perform when the rate cycle was about to turn. Yet each time they resumed market leadership when rates began to rise.
“The intention in each cycle was, as it is now, to slow the economy down and reduce aggregate demand to ease inflationary pressures,” he explained.
“That is much more of a headwind for cyclical and value stocks and for structural growth companies. Once the rate cycle is underway and inflation (and rate) expectations stop rising, then growth stocks tend to resume market leadership.”