6 key takeaways from Fidelity's 2022 outlook
Markets enjoyed a strong recovery through 2021, but that doesn’t mean they’re sailing in fair winds and following seas.
Uncertainty continues to be the order of the day, as new COVID variants, supply-side bottlenecks, and inflation stymie a full return to normality.
Fidelity has just released their 2022 Outlook (Catch 2022: Unravelling the policy paradox) with an around-the-ground series of summaries from their cadre of portfolio managers.
Here are some of the key takeaways.
China’s a bargain
China’s been buffeted by instability this year, and this is set to continue into 2022.
But there’s a silver lining – valuations have become more attractive.
“From a top-down perspective, the slowdown in China, driven by multiple factors including issues in the property sector, lower credit impulse, supply chain disruptions, and localised COVID outbreaks, remain a concern, and we think this backdrop will continue for the next few quarters,” says Amit Goel lead portfolio manager of the Fidelity Global Emerging Markets Fund.
“This is allowing us to buy some very competitive industrial and consumer businesses at reasonable prices.”
Jing Ning, Portfolio Manager of the Fidelity China Fund, agrees that valuations are becoming more attractive. But she points instead to inflation as the primary reason of this.
“Value’s outperformance relative to growth is driven by solid earnings revisions rather than multiple changes, and valuations remain depressed even after the strong performance of 2021,” says Ning.
She went on: "Value investing may continue to outperform growth next year, as value sectors provide good inflation hedges.”
Anthony Srom, portfolio manager of the Fidelity Asia Fund, attributes the attractive valuations to yet another cause - regulation.
“The positive news is that the market increasingly factors in regulation, and valuations have started to reflect this,” he says.
“For example, we’ve used negative sentiment towards the property sector and linked industries to buy Chinese paint company SKSHU Paint. Its stock price had moved significantly lower, but we took the view that even if new building developments slow, the demand for paint remains robust due to renovation and maintenance needs.”
Indeed, China's investable universe is increasingly being divided up along regulatory lines.
"From a regulatory perspective, the country’s focus has been on common prosperity and creating a more level playing field regarding competition, which should support consumption in the long run," says Aneta Wynimko, Alex Gold and Oliver Hextall.
"However, these policies could lead to short-term spikes in volatility."
This is funnelling investors into certain industries and out of others.
"Investors are exiting sectors that have been impacted by policy changes, such as the internet and education, and rotating into areas perceived to be less impacted, such as healthcare, sportswear, and renewables," says Ning.
"As a result, these sectors’ overall valuation premium versus the market has moved to an extreme level."
Also look to China's big tech names to lead the charge - Alibaba and Tencent.
"We remain bullish on large-cap technology companies in Asia, where valuations are attractive versus their long-term growth prospects," says Goel.
U.S. fiscal spend will be a windfall for sustainability assets
While ESG considerations were front of mind for all portfolio managers interviewed, Fidelity has a standalone fund dedicated to two ESG investment themes: water and waste.
The water and waste play is here to stay courtesy of a host of enduring megatrends.
“These include population growth, urbanisation, ageing infrastructure (that needs to be repaired or replaced), climate change, and the effects of altering weather patterns on existing infrastructure, the sustainability of resource consumption, and changes in the volume and composition of waste,” says Velislava Dimitrova and Cornelia Furse, portfolio managers of the Fidelity Sustainable Water and Waste Fund.
“Companies exposed to the value chains of these core themes should provide above-benchmark returns across the market cycle.”
It looks like the US infrastructure bill will benefit a number of these water and waste pure plays.
"One is Evoqua, a leading player in waste-water management and water treatment, which will be supported by demand for PFAS treatment as it is the dominant player in this market."
"Within the waste sector, one of our core areas of focus is sustainable waste practices. We look to invest in “future waste solutions” – businesses that recycle, recover, reuse, and reduce waste, or legacy incumbent waste providers that are shifting their businesses towards more sustainable waste practices."
Cost-push inflation continues to intensify
“In recent weeks, company management teams have warned about rising labour costs, which tend to be sticky,” according to says James Abela and Maroun Younes, both portfolio managers of Fidelity’s Future Leaders strategy.
“Labour cost is a key component of inflation, alongside housing.”
Bond markets have priced this in, however equity markets are yet to.
“This could lead to some choppiness and volatility as the equity markets digest this new reality.”
In inflationary environments, companies with clear competitive advantage, in industries with high barriers to entry, are best placed to come out on top.
“This approach is particularly important in inflationary environments, as these companies are more likely to price for higher input costs and offset inflationary pressures,” says Dimitrova and Furse.
Companies with strong competitive advantage are also in a position to pass along costs to consumers at less risk of customer churn.
"We believe that some of the best opportunities lie in high-quality companies with competitive advantages in good industry structures," add Abela and Younes.
"Such businesses will have some inherent pricing power, allowing them to protect margins by passing on increases in labour costs to consumers.
Uncertainty puts the focus on fundamentals
“We expect global mid-cap equities to generate sustainable and healthy returns, with investors paying more attention to fundamentals versus the momentum-driven recent past,” says James Abela and Maroun Younes, both portfolio managers of Fidelity’s Future Leaders strategy.
“Given our conservative view of the market, the primary way to generate performance is with careful stock picking, and there are still many interesting opportunities.
Select China A-shares continue to offer a good balance of risk and reward, plus large sentiment swings can present mispriced opportunities.”
A local example of this is Domino’s Pizza, which Paul Taylor, portfolio manager of the Australian Equities Fund, likes for its “robust franchise model offering attractive growth opportunities through store expansions and higher same-store sales.”
“… it also benefits from an attractive industry structure and efficient supply chain given its focus on technology, such as mobile ordering, as well as its management team, which is strategically focused on innovation."
Tight labour market bodes well for robotics and automation
The great resignation coupled with ongoing border controls have put upward pressure on labour costs.
One solution: robotics and automation.
"We feel that companies operating in the automation and robotics space remain particularly attractive, as employers continue to offset labour risks and a structurally shrinking workforce amid rising dependency ratios with automation and technologies aimed to enhance productivity," says Aneta Wynimko, Alex Gold and Oliver Hextall.
Lockdown consumption trends here for good
The lifestyle changes we made during lockdown are here for good.
"We are witnessing a notable acceleration in existing trends, such as e-commerce, the digital delivery of food and beverages, cashless transactions, and working from home, which will continue to shape the future – both in 2022 and over the longer term," says Taylor.
Add to this the return of all those things we missed doing the past two years.
"... the vaccination drive will facilitate economic activity, aid the resumption of travel and, most importantly, restore the quality of human lives."
He goes on: "We are currently in a transitionary phase, and as the borders open, we are likely to see the emergence of significant trends, such as a pick-up in travel given stifled demand."
If you want to read Fidelity's 2022 insights in full, they can be found here.
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David is a content editor at Livewire Markets. He currently hosts The Rules of Investing, a half our podcast where he sits down with leading experts across equities, fixed income and macro.