With tech sector and US stocks losing their shine, emerging markets are the ones to watch

While more modest corporate earnings and the quick pace of policy tightening have hurt the tech sector and US equity market, emerging market equities have been much more resilient
China’s looser monetary policy should lift its economy, with the positive effects spilling over to other closely linked economies

Patrik Schowitz

Published: 1:30am, 12 Feb 2022

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After another stellar year in 2021, global equity markets have had a difficult start to the new year, falling by 8 per cent as of late January, although they have recovered somewhat since. To make matters worse for many investors, two long-running market leaders, namely the US equity market and the global technology sector, have been under particular pressure.

A key driver of the change in market fortunes has been the rapid shift in mood by major central banks across the globe, from a very loose monetary policy stance towards a fairly rapid tightening. This shift was brought on by inflation pressures that have been much more stubborn and persistent than central banks had expected, particularly in the US.

However, another factor has recently become important in driving equity market nervousness: the outlook for corporate profits. Over the past 18 months, growth in corporate earnings has been so explosive that it has outweighed many investor concerns, such as Covid-19 disruptions or high equity valuations.

We are currently in the middle of the global earnings season, when companies report their quarterly results. Since early 2020, companies globally have repeatedly and resoundingly beaten analysts’ expectations, providing much of the fuel propelling markets higher.

Stock market information is seen at the Nasdaq MarketSite in New York on February 3. High-flying technology and internet companies have long been a pillar of market strength. Photo: Bloomberg

In this earnings season, it was hoped that much better-than-expected results for the last quarter of 2021 would again help soothe market nerves. While earnings growth is still solid by historical standards and results are still beating expectations, they are doing so by much smaller amounts than investors have become accustomed to.

There have also been more companies reporting difficulties, ranging from slowing demand to rising costs due to choked-up supply chains and tight labour markets as part and parcel of the widespread inflation issues.

A number of these problems are cropping up among highly-valued and previously high-flying technology and internet names, which have long been a pillar of market strength. This has been enough to raise questions about the long-term sustainability of these companies’ rapid earnings growth.

The technology sector’s high valuations have long been justified by reference to its superior profits growth, which investors regard as particularly valuable in an environment of low interest rates.

With rates rising and some doubts over the sustainability of the sector’s growth, it is therefore logical that it has come under pressure. Given that the US equity market is home to most of the big global tech and internet companies, it is no surprise that when the tech sector suffers, so does the overall US market.

In contrast, during this latest round of market turmoil, emerging and Asian equities have been much more resilient than developed market equities, with Hong Kong leading the outperformance this year. There are two key reasons for this relative resilience.

First, emerging market equities as a whole underperformed in 2021, mostly driven by China’s stumbling economy. Therefore, valuations now look much more attractive, if not outright cheap.

Second, China’s macro policy is going in the opposite direction to the broad global trend, loosening, while most of the central banks in major economies like the US and the UK are in a tightening mode, with the euro-zone area expected to follow later this year.

Why market expectations of China policy easing will fall flat

At least in a relative sense, this looser policy should help the Chinese economy, companies and equity markets. The positive effects are also likely to spill over to other closely linked economies.

Indeed, there are already early signs that earnings among emerging market companies are beginning to stabilise after a prolonged period of weakness – just as the earnings picture in developed markets is beginning to look less stellar.

This is not the time for exaggerated gloom. It is likely that a still-robust global economy will continue to drive company earnings, and thus equity markets, higher over time, at least until we get to the next recession, likely to be a few years away.

The outlook for global equities is likely to be more modest and volatile, but also probably more balanced, with the shine probably coming off the technology sector somewhat and emerging markets rejoining the fray.

Patrik Schowitz is a global multi-asset strategist at JP Morgan Asset Management

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