7 January, 2025.
Beyond the alarming headlines around Trump’s trade policy, US trade protectionism and a more aggressive stance towards China is not a new phenomenon. Many measures introduced in Trump’s first administration were left unchanged under President Biden. Of course, there is much uncertainty around the eventual magnitude and focus of any new tariffs under Trump 2.0 – and whether tariffs are used as a stick, a carrot or as a genuine means to rebalance trade – but the impact on individual emerging markets is likely to be highly diverse, regardless.
Kent: Post election, rather than succumbing to a blanket sell-off, emerging market performance was mixed. This highlights the huge diversity of the investment universe – in terms of economic structure, fundamental strength and trade relationships. While Trump 2.0 raises uncertainty around the size and shape of future tariffs, any impact on emerging markets will be far from uniform. Winners will coexist with losers. For instance, a global rewiring of supply chains to increase resilience was set in motion some years ago – other emerging market economies will continue to benefit from diversification away from China, and the US cannot start to produce many of these goods immediately, but a gradual shift makes for less sensational headlines.
Hart: “Additionally, the new Trump administration could bring some positive developments for emerging market investors. Trump’s apparent desire to bring an end to various conflicts – namely in Ukraine and the Middle East – could remove the geopolitical risk premium priced into many emerging market assets.”
A key consideration for investors weighing tariff risk is that China's exports to the US have fallen over the past decade and today only account for 14%1, more than 25% lower than a decade ago. In the eight years it has had to adapt to a change in US policy, China has been working steadily to diversify its trading relationships. Instead of fixating on events in Washington DC, investors would do well to focus on China’s domestic economic policy.
In that vein, even if the China growth story is no longer particularly exciting and a growth miracle appears unlikely, China’s economy today appears somewhat more underpinned – with the government essentially showing its willingness to provide a safety net and remove some potential downside risk. While stimulus measures announced towards the end of 2024 were met with some disappointment – notably among the fixed-income investment community – their inclusion of vital support for China’s property market marked a line in the sand. That has taken some of the more negative risk scenarios off the table, which is good news for all emerging market economies.
Hart: “While many market participants continue to focus squarely on the macroeconomic picture in China, the view from the bottom up is a lot more interesting. There are plenty of interesting Chinese stocks to invest in, typically relating to three key shifts taking place in China. Firstly, Chinese consumers are trading down from luxury labels, favouring more value products to save money. Secondly, China’s ageing population means that demand for healthcare, pensions and life insurance is rising. There are already compelling investment opportunities to be found in companies catering to all of these. Finally, in recognition of today’s different operating conditions, many companies in China are restructuring, reducing costs, boosting earnings and actually paying a lot more back to shareholders in terms of buybacks and dividends.”
1 Ninety One, Bloomberg, 31 December 2023.
The consensus case for US dollar strength – relating to higher interest rates in an economy that has performed exceptionally well; the potential weight of tariffs on other currencies; and the fact that major currencies like the euro are not posing any real challenge – appears compelling in the short term. However, the extent and duration of any potential dollar strength-related headwinds may prove more benign than many fear, and typically when markets are making a one-way bet they have been proven wrong. Furthermore, a strong dollar is diametrically opposed to some of Trump’s key policy ambitions: to rebalance trade and rebuild the Rust belt. In short, looking past the noise, there are reasons to question the assumption that the dollar will remain exceptionally strong for a protracted period.
Hart: “In the next three to five years, India could overtake China to become the largest emerging equity market. This is a transforming economy, with a range of government policies implemented over the past few decades now feeding through into economic growth and company profits. Perhaps one of the most significant, but least talked about, is the initiative to give everybody an identification number (Aadhaar), effectively allowing 500 million people to become economically active; the scale of this rise in economic participation is staggering.”
However, the more visible and tangible transformations in India – a country that’s building 45 kilometres of road every day, creating its first high-speed railway, undertaking a variety of metro projects, and building new ports, etc. – have not gone unnoticed by investors. India’s equity market is now trading at a growth premium; expectations are high, and valuations look stretched. Yet there are some great companies to invest in – should a correction take place in the equity market in 2025, valuations should become more reasonable. In the meantime, investors need to be highly selective and avoid getting caught up in the euphoria.
Kent: “Turning to India’s fixed income market, the country’s inclusion in the flagship emerging market local bond index in 2024 underscores the maturity of the asset class. Significant evolution over the past 20 years has created a higher quality, more diverse and less volatile market, with India’s inclusion a welcome development in that regard.”
Chinese manufacturers could see a significant growth opportunity in Africa and Asia. They are huge markets that are growing considerably faster than Europe and the US with much less capacity and far lower competition. Companies that position themselves to benefit from this shift look poised for strong growth.
Elsewhere, a range of very diverse economies are benefiting from supply chains resetting and shifting around. For instance, Eastern Europe has become an attractive destination for German and French companies to outsource to. In Asia, ASEAN2 markets are benefiting from companies moving out of China and looking to diversify some of their risk. Investors can find plenty of interesting opportunities in this category. Hart: “Although it's going to be increasingly difficult for China to sell an electric vehicle into the US or Europe, taking a pan-emerging market view, there is significant growth potential in another sector: technology. Between 35% and 40% of the market cap in emerging markets is now technology related in one form or another. The tech sector is what has driven the US equity market in recent years; a similar phenomenon could drive emerging markets going forward, with the potential to take many market participants by surprise.”
2 ASEAN - Association of Southeast Asian Nations.
In emerging market fixed income portfolios, the short-term outlook – reflecting growth-friendly policy in the US and the potential for more expansionary policy in China – favours higher carry and higher yielding markets. Investors should be selective in their FX market positioning given the uneven impact of potential tariffs and uncertainty around these. In local rates markets, there are still plenty of economies where real (inflation-adjusted) interest rates are exceptionally high, creating a positive outlook for bond prices.
The local debt markets of several frontier countries look attractive. These economies have undergone substantial domestic policy shifts over the last year and their debt offers investors relatively high yields and low volatility compared with more established emerging markets. Furthermore, this debt is typically less correlated to broader moves in US Treasury yields.
Among emerging market corporate debt issuers, yields look compelling across the ratings spectrum as the outlook for company fundamentals appears benign, with default rates expected to be low thanks to manageable levels of debt and refinancing risk, even in the event of a punitive tariff regime. While credit spreads are historically tight (like in all credit markets), a bottom-up investment approach still reveals plenty of individual opportunities that offer attractive value – these exist across the ratings spectrum and across geographies.
From a regional perspective, while corporate bond valuations in some Asian markets look quite expensive, pockets of value can still be found, particularly in India where companies are benefiting from positive macroeconomic growth stories. Elsewhere, we believe that there are attractive opportunities in parts of Latin America, including Brazil and Colombia, in sectors such as oil & gas and metals & mining. And while Mexico could come under pressure from tariffs and immigration policy from the Trump administration, we believe the country still offers interesting opportunities in domestically oriented sectors such as utilities and banking, which are relatively insulated from this dynamic. Considering the global opportunity set, the utilities sector looks compelling from a broader perspective given its defensive nature and its exposure to renewable energy, which will be supported by the global transition towards net zero.