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Should fear trump hope in emerging markets?

  • 04Jan 17
  • Joanne Irvine Head of Emerging Market Equities, ex-Asia

Donald Trump is set to become the next president of the United States, and the world has to grapple with the implications. Emerging economies, among the biggest beneficiaries of globalization, are watching with trepidation as the self-styled architect of ”Brexit*-plus-plus-plus” threatens to undermine a rules-based international system of trade and investment that took decades to build.

What a Trump presidency will look like is still unclear because his speeches have been conspicuous in their lack of policy detail. However, protectionism has been a recurring theme, and it’s one that plays well with American voters fed up with income inequality, “stolen” jobs and “unfair” foreign competition. In fact, his victory, like Britain’s decision to leave the European Union, can be seen as a vote against the status quo.

Trump’s pledge to restrict immigration and rethink the North American Free Trade Agreement (NAFTA) will be a blow to neighbor Mexico, whose currency has hit new lows. In contrast, Brazil, Latin America’s main economy, is less exposed to the U.S. and more vulnerable to fluctuations in Chinese demand. Trump’s intention to increase infrastructure spending could even boost Brazil’s iron ore exports.

While a setback, it’s hard to mourn something that exists only on paper and excluded China, the region’s heavyweight.

Prospects for the Trans-Pacific Partnership, an Asian free trade agreement, are grim. To be fair, Trump isn’t solely to blame. Hillary Clinton also withdrew her support, despite promoting it in office. While a setback, it’s hard to mourn something that exists only on paper and excluded China, the region’s heavyweight. Beijing has cheekily floated a substitute deal, albeit one that would follow its rules.

Trump will likely continue his criticism of China. It has become something of a U.S. election ritual for candidates to bash China, although once in power, most swapped ideology for pragmatism. In Trump’s case, he has pledged to declare the country a “currency manipulator” as one of his first official acts. This initial step that could lead to the imposition of trade tariffs.

It’s still early, but investors have dumped emerging-market stocks, bonds and currencies. Not only are there concerns over protectionism, but Trump’s tax cuts and fiscal stimulus will also boost borrowing and force interest rates upward. That is positive for the dollar but negative for emerging markets, which may suffer capital flight after having clawed back flows in recent months as investors saw improving fundamentals.

A longer-term question is whether Trump’s policies, if enacted, won’t be self-defeating. Protectionism is likely to add to inflation in the U.S. by making goods more expensive. Under this scenario, U.S. companies would become less competitive, and eventually U.S. growth would slow. Meanwhile, higher government spending, despite lower tax revenues, would lead to a wider fiscal deficit.

How this all turns out may depend on how well Trump and his fellow Republicans get along. Many Republicans publicly distanced themselves from him on the campaign trail. Now they must recognize he has helped return them to power. Trump’s interventionist instincts are at odds with their free market, minimal government ethos. At this stage, whether or not he will use executive orders to get his way or seek compromise is unknown.

Europe is the next battleground.

Trump’s victory therefore adds to existing uncertainty in the world. We expect his success to embolden like-minded politicians elsewhere to agitate for similar policies. Europe is the next battleground. While emerging countries do not face the same political concerns, rising nationalism could threaten the security as well as the trade on which post-war prosperity has been built.

That said, there is cause for hope. Developing economies, on the whole, are in a better position to weather uncertainty than even a few years ago. Economic and monetary policies are very orthodox and this has been paying off. Inflation is largely under control or falling. Currency weakness may slow but should not prevent central banks from cutting interest rates to support growth. At the corporate level, there are signs the earnings cycle is turning for the better.

In the long run, the imposition of trade barriers may force some of the bigger emerging markets to accelerate efforts to shift from export-led growth to consumption-based models. China, for example, would finally have the catalyst it needs to fully embrace the painful structural overhaul it has been delaying.

Despite everything that is going on, emerging markets are still regions of unprecedented wealth creation where the scope of economic activity still isn’t fully reflected in stock market capitalization. Growing middle classes are driving demand for everything from milk powder to cars. These regions will grow faster than the developed world for years to come. Unlike the financial markets or even changes in political climate, this is structural, not cyclical.

*Brexit is an abbreviation of "British exit,” which refers to the June 23, 2016 referendum by British voters to exit the European Union.

Important Information

Fixed income securities are subject to certain risks including, but not limited to: interest rate (changes in interest rates may cause a decline in the market value of an investment), credit (changes in the financial condition of the issuer, borrower, counterparty, or underlying collateral), prepayment (debt issuers may repay or refinance their loans or obligations earlier than anticipated), call (some bonds allow the issuer to call a bond for redemption before it matures), and extension (principal repayments may not occur as quickly as anticipated, causing the expected maturity of a security to increase).

Foreign securities are more volatile, harder to price and less liquid than U.S. securities. They are subject to different accounting and regulatory standards, and political and economic risks. These risks are enhanced in emerging markets countries.

Image credit: Win McNamee / Getty Images

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