JAN 2022

Outlook on Emerging Markets

RD12136

EquityBig Winds Are BlowingThe MSCI Emerging Markets Index ended the year down 2.5%, underperforming the developed markets MSCI World Index by approximately 24%. The top three performing markets in 2021 included the Czech Republic, United Arab Emirates, and Saudi Arabia, and the bottom three markets were Turkey, China, and Peru. The top three performing sectors included energy, utilities, and information technology, and the worst-performing sectors were consumer discretionary, real estate, and healthcare.

One of the most subtle trends of the past year has been a shift in style performance. Over the past year, emerging markets value stocks have returned 4% compared to -8% for emerging markets growth stocks, but we are not yet ready to declare that there has been a definitive change in style leadership. Part of what has helped value outperform in 2021 has been the fall of many expensively valued Chinese equities (e.g., platform economy companies, online education, gaming, etc.), which have been caught in the net of changing regulations.

However, the course of growth across emerging markets, like for the rest of the world, will undoubtedly be linked to a few great uncertainties: the path of the pandemic and its variants, government response to the pandemic, whether inflation is truly transitory, and the state of global geopolitics.

The Virus Has Us Vexed—and VIXedCOVID-19 surges continue to weigh heavily across the globe—tamping travel, closing borders, and wreaking waves of general uncertainty. The trajectory of COVID-19 and the impact variants may have on a global economic recovery continue to be ambiguous, and therefore, we believe that investors should stay strapped in for more uncertainty over at least the next quarter.

While stocks have begun to react following recent news that the latest COVID-19 variant, Omicron, may be less severe although more transmissible than expected, it is obvious that any pandemic uncertainty can dramatically shape markets. At the start of December,

Summary � The course of growth across emerging markets, like for the rest of the world, will undoubtedly be linked to a number of deep uncertainties including the effect COVID-19—and its potential variants—may have on economies.

� While regulations over the past year and Beijing’s drive for “common prosperity” have led to losses, some investors think the current regulatory cycle in China is slowing, which would be helpful for equities, particularly for the technology companies that have been most affected.

� Near-term challenges facing emerging markets debt are likely not insurmountable, and the current level of pessimism priced into markets has driven valuations to levels that provide more than adequate compensation for these risks.

� We continue to favor credit, both sovereign and corporate, particularly in high yield, as emerging markets sovereign valuations appear cheap relative to investment grade valuations and also relative to some US corporate credit.

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the Cboe Volatility Index (VIX), which tracks fluctuations, or volatility, in the S&P 500 Index, climbed to over 31, reaching new quarterly highs on the variant news before waning.

As we learn more about Omicron, market scenarios continue to be hypothetical and variable. However, some risks and reactions seem more likely than others, in our opinion. We have outlined possibilities here:

� What if: Omicron packs a wallop to community health and wellness?

• Consumer spending could drop, labor shortages worsen, and supply chains choke, further dampening production, output, and growth in emerging markets.

• Disruption to recovery (including pace) and recession are possi-ble, with tighter conditions affecting business, travel, leisure, and consumption across world economies.

• Accelerating inflation triggers interest rate hikes, which, for emerging markets, already began in 2021. Fourteen emerging markets central banks took an aggressive stand against inflation during the past year, raising rates, on average, 153 basis points (bps).1

• Perception that central banks like the US Federal Reserve have little room to maneuver could push up the US dollar and weigh on emerging markets.

� What if: Omicron is the next normal, or becoming endemic, and 2022 is largely business as usual?

• Higher inflation, but not structurally high inflation? Some infla-tion relief at the onset of the year could be expected as demand is rebalanced and restrictions ease, while global and emerging economies continue on a mostly positive course.

– Such an outcome would likely be good for value stocks, which tend to come from cyclical industries like energy, utilities, and manufacturing, which should see a boost as demand for ser-vices accelerates following the “shutdown slump.”

• Recovery continues across the board as the need for goods and labor ramp up.

Importantly, it is the depth of uncertainty that remains most crucial when we consider the effect COVID-19 and its potential variants may have on emerging and global economies into the new year. We believe that it is how governments around the world (new lockdowns, travel restrictions, vaccine or booster accessibility) and central banks (tapering plans, rate hikes) respond to virus uncertainties that will most affect growth and confidence in emerging markets.

InflationInflation rates have spiked higher in the latter half of 2021 (Exhibit 1). While inflation and the Fed’s recent hawkishness are still seen as some of the primary risks facing global financial markets today, economic growth and inflation worries are expected to moderate in 2022. The United States and Europe have been the global growth drivers in this most recent economic rebound and tend to dominate market risk perceptions. Slower growth in these areas should translate into slower growth in world trade (Exhibit 2) and manufacturing, which should allow for supply chain stresses to ease and elevated upstream prices to decline.

China Looks Set to Begin Its Next ChapterChina’s barrage of regulations over the past year and Beijing’s drive for “common prosperity” have led to market value losses of more than $1 trillion and raised doubts about the country’s commitment to a market-based economy. Profit margins have been squeezed at a time when electricity shortages, a real estate sector downturn, and virus outbreaks have been weighing on economic conditions. Manufacturing activity (as measured by PMI) declined for seven consecutive months before rebounding in November and December. Against this backdrop, prices have been pushed higher along with the risk of stagflation.

Recently, Chinese officials have begun taking steps to try to stave off a deeper slowdown. In December, the People’s Bank of China (PBoC) reduced the reserve requirement ratio by 0.5%, releasing 1.2 trillion yuan ($188 billion) of liquidity. A cut in the reserve ratio does not directly lower borrowing costs; however, it unleashes cheap funds for banks to lend. In its statement, the PBoC highlighted that the cut is not the beginning of an easing cycle, but rather a “regular monetary policy action.”

Exhibit 1Emerging Markets vs. Developed Markets Inflation

-2

0

2

4

6

8

10

2020201820162014201220102008

Developed EconomiesEmerging Economies

CPI (YoY% Change)

As of 31 October 2021 (Emerging Economies) and 30 September 2021 (Developed Economies)

Source: Haver Analytics

Exhibit 2World Trade Volume Growth

3mma (YoY%)

-20

-10

0

10

20

30

202120192017201520132011

As of 30 September 2021

Source: Haver Analytics, Netherlands Bureau for Economic Policy Analysis

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Adding to this, in a draft of its new rules for Chinese companies listing overseas, the China Securities Regulatory Commission (CSRC) is planning to remove the variable interest entity (VIE) route, citing data security concerns. To tap into foreign capital, Chinese internet companies such as Alibaba and Tencent have historically used the VIE structure, which allows a Chinese company to transfer profits to an offshore entity that issues shares to foreign investors. Companies currently listed in the United States and Hong Kong that use VIEs would need to provide more transparency about their ownership structures in regulatory reviews. It remains unclear how the shareholder structure would change, or if the most sensitive firms will choose to delist in the United States, possibly in favor of Hong Kong or mainland China.

In the United States the Securities and Exchange Commission finalized plans for a new law that would require foreign companies to make their audit books available for review or risk being delisted from equity markets. The law is expected to go into effect, at the earliest, in the first quarter of 2023. Chinese companies would have to specify in their annual reports the percentage of shares that are owned by a government entity, whether government entities have a controlling financial interest, and the name of each member of the Chinese Communist Party who sits on the board.

That said, there are some options for Chinese ADRs, including conversion to Hong Kong-listed shares or seeking a secondary listing in Hong Kong. Currently there are more than 220 Chinese companies that are not listed in Hong Kong with a total market capitalization of $360 billion. Most of the dual-listed Chinese ADRs, around 17 companies representing 69% of total market capitalization, have the ability to convert their ADRs to Hong Kong-listed shares. The most likely path for Chinese ADRs that are not currently listed in Hong Kong is to seek a secondary listing in Hong Kong first. Didi Chuxing Technology, the Chinese ride-hailing company, is one example of a Chinese company that announced it would delist in the United States and prepare to go public in Hong Kong.

Many investors have a sense that the current regulatory cycle in China is slowing down, which would certainly be helpful for the equities market, particularly the technology names that have been most affected. Chinese companies are no stranger to the idea of government-mandated changes in their scope of operations and have a history of adapting to changes like the ones we have seen over the past year. It is important for investors to remember that many world-leading businesses in areas such as digital payments have been built in China. They are quickly innovating and becoming a global force in strategic areas such as semiconductors and artificial intelligence (which the government is actively encouraging, rather than limiting), and has yet to unlock the full potential of its large and growing middle class. Our value strategies are looking for new pockets of attractively priced stocks, while our more growth-oriented strategies are actively thinking about where the next growth opportunities are, including potentially a recovery in Chinese equities and its economy. Either way, we believe that investors must be alert to risks, but it is too soon to count China out in 2022.

Is Russia Playing with Fire?Energy has become a critical element of Russia’s geopolitical evolution. Gazprom, the country’s largest state-owned gas company, has influence over one-third of all gas storage in Germany, Austria, and the Netherlands, where there have been recent significant storage shortfalls. The company also benefited from strong gas price increases in the last eight months. Many believe that President Vladimir Putin is using the pressure of higher gas prices as an attempt to force the European Union into approving the Nord Stream 2 pipeline between the North Sea and Germany. Putin has refuted these claims, blaming the crisis on failures at other European energy companies, which he suggests did not pump enough gas before winter, squeezing supply and fueling inflation.

To make matters more complex, Russia has amassed troops near the Ukrainian border. Investors now find themselves watching a game of geopolitical brinkmanship. Even as US Secretary of State Antony Blinken reaffirmed that the American commitment to Kyiv remained “ironclad,” questions about Putin’s intentions for the region remain unanswered. This most recent military escalation is being viewed in a number of ways: as an effort at reunification of culture, language, and people; as a means to block NATO’s advances and growing influence; and, again, as a way to gain leverage for the approval and development of the Nord Stream 2 natural gas pipeline, which is expected to double Moscow’s gas exports to Germany and could become a potential political weapon.

Given increased geopolitical risks, investors have tended to reduce exposure to Russia while keeping a close eye on how political developments affect Eastern European companies as well.2

Can Brazil Stage a Comeback?At first glance, there seems to be little hope for optimism in Brazil. The country slipped into recession in the third quarter for the second time since the pandemic started after extreme weather, supply chain disruptions, and heightened inflation weakened Latin America’s largest economy. A near 10% decline in the export of goods and services also led GDP lower as global supply chain issues and rising raw material costs weighed on producers. The twin ills of high inflation and high unemployment (12.6%) hit households particularly hard, and the central bank has been forced to fight inflation by hiking interest rates, rather than easing to grease economic conditions.

Political uncertainty ahead of general elections in October 2022 has been a key reason for investors to shy away from Brazil. Investors aren’t particularly enthused by either the prospect of another term for far-right President Jair Bolsonaro, who downplayed both the risks of the virus and the efficacy of vaccines, or leftist former President Luiz Inácio Lula da Silva, who spent time in prison for his role in a corruption scandal. The latest two polls leave little room for uncertainty on who the winner would be today: Lula. The closer we get to the October election, the more closely investors will look for clues about the economic plans of candidates, especially those of the frontrunner. Any move toward the center, particularly in macroeconomic matters, by Lula and the left could provide a level of comfort to investors. There are several other candidates in the running as well, namely former federal Judge Sergio Moro and São Paulo Governor João Doria, and we think a show of strength by any of them could be very good for the equities market.

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But it’s easy to forget, too, that before COVID-19 Brazil had enacted several important reforms, including privatizing some state-owned assets to bring more foreign investment into the country and reforming the social security system. In addition, thanks to a strong public health system and a long history of providing mass inoculations for diseases such as yellow fever, Brazil’s vaccination rate was higher than that of the United States as of late December 2021, something it accomplished in spite of its early lack of success in managing the pandemic. We are keeping a close eye on Brazil’s election, but feel that the deep sell-off in the country this year may have created opportunities to invest in undervalued businesses that could benefit from a cyclical recovery if COVID risks recede.

India Keeps Growing ForwardWhen investors sold down China, they went to India. The Indian equity market has been the beneficiary of strong inflows from both the institutional and retail markets, pushing the MSCI India Index 20% higher this year. Investors were particularly enthusiastic about using Indian tech stocks to fill a void left by the Chinese tech giants getting battered by regulation, but it’s unclear how long that trade will play out. Competition to buy stakes in early-stage tech companies has increased valuations considerably, and the market cooled slightly after a disappointing initial public offering from the payments company Paytm.

However, growth projections remain strong, and India’s continuing efforts at economic reform make it a particularly interesting proposition for long-term investors to keep an eye on. After a year of robust manufacturing and services sector demand, supported by heightened vaccination rates, India’s GDP has grown 8% year over year. Looking ahead to 2022, growth forecasts remain strong with projections coming in at record levels. Recently, the International Monetary Fund (IMF) projected 8.5% growth for the country, and many large financial institutions are projecting north of 9%.

ConclusionWhile the first quarter of 2022 has some elements of déjà vu, we think weathering the current market uncertainties, from pandemic unknowns to political showdowns, should remain a leading driver for market participants. Preparing for likely volatility—and the potential for big shifts from pitfalls to opportunities—will require some new planning and could lead investors through the hardest parts with greater confidence.

DebtA Rocky Path in 20212021 was a challenging year for nearly all fixed income asset classes. Expectations of increased fiscal stimulus in the United States and growing optimism about the global economic recovery led to a substantial and rapid rise in long-term Treasury yields in the first quarter of the year. As the year progressed however, uncertainty stemming from the emergence of new coronavirus variants supplanted that optimism, and fears of persistent inflationary pressures gave rise to concerns that the US Federal Reserve may soon unwind its highly accommodative policy support.

As was widely telegraphed, the Fed began tapering its $120 billion per month asset purchase program in November. The Fed then pivoted toward a more hawkish stance at its final meeting of the year in December by announcing that it would accelerate the tapering timeline to a pace that would end the program altogether in March of 2022, a few months ahead of the initial target, and opened the door to a liftoff in the federal funds rate as soon as tapering winds down. Over the course of the past several months, market participants have brought forward rate hike expectations, leading to a flattening of the yield curve and renewed strength in the US dollar.

Emerging markets debt wasn’t spared this difficult landscape (Exhibit 3). Hard currency sovereign debt was down around 2%, roughly in line with traditional US fixed income. Local currency debt fared worse than hard currency debt for the ninth time in the past decade, falling almost 9%. Local debt was hit by a double whammy of rising yields and weaker currencies as emerging markets central banks began the process of policy normalization and commenced tightening cycles in an effort to stabilize inflation expectations. In the end, 2021 marked the worst year for local currency debt since 2015 and its third-worst year in the nearly 20-year history of the asset class. Emerging markets corporates were the lone bright spot across emerging markets debt, eking out a positive gain on the year and outperforming hard currency sovereigns for the second consecutive year. In general, corporates benefited from a shorter duration profile and strong corporate balance sheets, while the sharp sell-off in the high yield real estate sector in China was contained.

Uphill RisksAs we head into 2022, the financial media and many market participants have focused on the uphill battle facing emerging markets debt. Among the commonly cited risks are:

� slowing global growth

� persistent inflationary pressures

� Fed rate hikes

Exhibit 3A Challenging Year for Fixed Income

(%)-10 -8 -6 -4 -2 0 2 4 6

GBI-EM GD

EMFX

Global Agg

US Treasuries

EMBI GD

US Agg

CEMBI BD

CEMBI BD HY

US High Yield

TIPS

As of 31 December 2021

Source: Lazard, Bloomberg Barclays, JPMorgan

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Each of these risks warrants a detailed analysis; however, it is important to note that a significant degree of negativity is already priced into the asset class. Thus, if these risks prove to be less damaging to emerging markets prospects than the market currently expects, the asset class should earn significantly better returns in the year ahead.

Slowing Global GrowthGlobal growth expectations have steadily declined over the past several months, particularly as China’s growth has slowed. Year-over-year real GDP growth in the world’s second largest economy slowed from 7.9% in the second quarter to 4.9% in the third quarter, which was below consensus expectations. China’s growth outlook has further darkened, owing to supply chain disruptions, a sharply slowing property sector, a prolonged zero-COVID policy, and continued decarbonization efforts. However, it is important to note that global growth is moderating from very high levels and that the expansion is set to continue into 2022 at an above-trend pace for both developed and emerging markets.

In addition, some of the headwinds from 2021 could turn into tailwinds in 2022. Manufacturing output should recover as kinks in supply chains work themselves out. And thanks to lower spending and strong equity markets, consumers have accumulated excess savings, which could spur consumption when confidence improves. Finally, continued medical progress in the fight against COVID should render the virus less impactful to the global economy.

Persistent Inflationary PressuresAt the same time that global growth is moderating (but likely to remain supportive in 2022), inflation has surprised to the upside, reaching multi-decade highs. Multiple factors contributed to the inflation spike, including soaring commodity prices and ongoing supply chain disruptions. While inflation has risen across nearly every region, emerging economies have felt the surge in prices more intensely given their higher sensitivity to food and energy prices. Emerging markets central banks also lack the credibility that developed markets central banks have earned through a track record of keeping a lid on inflation. As a result, many emerging markets central banks were forced to normalize policy and commence tightening in 2021 in an effort to stabilize inflation expectations (Exhibit 4). Central banks in Brazil and Russia moved early and aggressively, signaling their determination to manage inflation expectations at a time when communication from core central banks was still dovish. Others, such as Mexico, Hungary, Chile, and Poland, moved later, but have since accelerated the pace of hikes as inflation has risen faster than expected. A few central banks, mainly in Asian countries, have had the benefit of holding out amid relatively benign outlooks.

We expect further rate hikes in 2022, but the pace and number of rate hikes should recede after the first quarter, assuming that growth converges toward trend levels and supply chain disruptions continue to normalize. Additionally, the increased credibility of some of the more hawkish central banks, such as the Central Bank of Russia, should help bring inflation expectations back toward targets.

Fed Rate HikesThe Fed has recently pivoted to a more hawkish stance, indicating that it believes inflationary pressures will prove more persistent than previously thought. As a result, market participants have pulled forward the anticipated timing of hikes in the fed funds rate (Exhibit 5). Prior to the September Federal Open Market Committee meeting, the market expected liftoff to occur in 2023 with 50 bps of hikes projected over the next two years. With an earlier end to tapering, the Fed now has the option to begin the tightening cycle as soon as March 2022, which is what the market expects. Markets are currently projecting three rate hikes in 2022 and a total increase of 150 bps in the fed funds rate over the course of 2022 and 2023. However, a March liftoff is far from a certainty, in our view. If inflation cools, as we expect, the Fed will be a lot less eager to move, and policy could remain on hold for longer than markets currently think.

Exhibit 4EM Central Banks Started Tightening in 2021, but Still Have Further to Go

-2

0

2

4

6

YTD Hike Expected Change to YE 2022

(%)

Czec

h Re

publ

ic

Ukra

ine

Chile

Peru

Pola

nd

Mex

ico

Colo

mbi

a

Kaza

khst

an

Rom

ania

Sout

h Af

rica

Indo

nesi

a

Thai

land

Mal

aysi

a

Phili

ppin

es

Egyp

t

Turk

ey

Russ

ia

Hun

gary

Braz

il

As of 8 December 2021

Source: Lazard, Bloomberg

Exhibit 5Expected Fed Funds Rate Hikes

(%)

0.0

0.5

1.0

1.5

Total20232022

Sep 2021 Nov 2021 Dec 2021

As of 10 December 2021

Source: Barclays Research, Bloomberg, NY Fed Survey of Primary Dealers

Outlook on Emerging Markets

In our view, the biggest risk for emerging markets in 2022 is that the Fed makes a policy mistake and raises rates just as the economy and inflation start to cool. This would present a significant challenge for all risk assets, including emerging markets, given the fragility of the global economic recovery. Inflation remains at elevated levels in the United States and no one knows when it will recede. We are of the view that inflation should soon show signs of cooling, leading the Fed to back off its recent hawkish pivot. Our base case currently remains that when the Fed does raise rates, it will be for the “right” reasons—a better growth outlook, as opposed to inflationary concerns. Additionally, with a number of rate hikes already priced into the markets and an expected terminal rate of around 2.25%, we see limited risk of a sharp, accelerated move in Treasury yields, and instead expect a more gradual increase in rates.

Better Views at the Top of the HillWe acknowledge the near-term challenges facing emerging markets debt, but we do not see them as insurmountable. In fact, we believe that the current level of pessimism priced into markets has driven valuations to levels that provide more than adequate compensation for these risks. Importantly, we think the market environment going

forward is likely to resemble that of the past two years, with a high degree of differentiation among sub-asset classes and individual issuers. Thus, a flexible, dynamic approach will likely be key in navigating the changing landscape.

We continue to favor credit, both sovereign and corporate, particularly in high yield. Emerging markets sovereign valuations appear cheap relative to investment grade valuations and also relative to rating- and maturity-matched US corporate credit. Even absent a catalyst for recovery, significant spread tightening for yields of 6%–7% in BB and B rated issuers is attractive, in our view. Elevated commodity prices should continue to support commodity-sensitive sovereigns, especially oil exporters.

In investment grade debt, spreads have also widened from their recent tights, albeit to a lesser extent. Still, our outlook for stable to slightly higher Treasury yields should not be disruptive for investment grade bonds and we see attractive carry opportunities in select countries with steep curves. Accordingly, we have maintained an emphasis on high yield sovereigns and corporates. We continue to emphasize BB and B rated issuers where we see a combination of solid fundamentals and attractive valuations, with a particular focus on countries in the middle of positive structural reform, often with IMF support.

This content represents the views of the author(s), and its conclusions may vary from those held elsewhere within Lazard Asset Management. Lazard is committed to giving our investment professionals the autonomy to develop their own investment views, which are informed by a robust exchange of ideas throughout the firm.

Notes1 Source: UBS Global Research, “EM Banks Outlook 2022.” As of 6 December 2021

2 Source: Ipec and Datafolha

Important InformationPublished on 5 January 2022.This document reflects the views of Lazard Asset Management LLC or its affiliates (“Lazard”) based upon information believed to be reliable as of the publication date. There is no guarantee that any forecast or opinion will be realized. This document is provided by Lazard Asset Management LLC or its affiliates (“Lazard”) for informational purposes only. Nothing herein constitutes investment advice or a recommendation relating to any security, commodity, derivative, investment management service, or investment product. Investments in securities, derivatives, and commodities involve risk, will fluctuate in price, and may result in losses. Certain assets held in Lazard’s investment portfolios, in particular alternative investment portfolios, can involve high degrees of risk and volatility when compared to other assets. Similarly, certain assets held in Lazard’s investment portfolios may trade in less liquid or efficient markets, which can affect investment performance. Past perfor-mance does not guarantee future results. The views expressed herein are subject to change, and may differ from the views of other Lazard investment professionals. This document is intended only for persons residing in jurisdictions where its distribution or availability is consistent with local laws and Lazard’s local regulatory authorizations. Please visit www.lazardassetmanagement.com/globaldisclosure for the specific Lazard entities that have issued this document and the scope of their authorized activities.