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Jan van Eck, CEO
Eric Fine, Portfolio Manager, Emerging Markets Fixed Income Strategy
David Semple, Portfolio Manager, Emerging Markets Equity Strategy
The election of Republican Donald Trump has led to an acceleration of the trends that we discussed in our
November 3 blog - Stars Align for Emerging Markets Equities. The primary trend we predicted was a downside for bonds and an upside for equities. Although both candidates promised to stimulate the economy through more infrastructure spending, Trump is likely to combine spending with tax reform and less regulation.
As markets have reacted in the past few days, what has been most surprising is the response from emerging markets (“EM”). EM currencies and bonds sold off heavily last week; this was primarily due to concerns about Trump’s potential trade policies, combined with a move upwards in global rates. Here are some observations from our emerging markets investment teams.
Key considerations for emerging markets bond investors from Portfolio Manager Eric Fine.
China’s Impact on Local Currencies in Emerging Markets
Trump has promised to name China a currency manipulator. China’s currency has recently appreciated against the emerging markets currencies in its basket, creating additional devaluation pressure. Moves in this direction would be negative for emerging markets foreign exchange (“EMFX”) as China is a crucial marginal buyer of commodities. China also faces some capital outflow pressures which could be exacerbated in the event of further currency weakness or a policy challenge from the U.S.
European Fragility May Increase Volatility
Upcoming European risk events such as the Italian referendum, and the Dutch and French elections can now be viewed through the lens of the U.K.’s Brexit decision and Trump’s victory. We view Europe as fragile and thus vulnerable, so political pressure could create volatility. If this volatility triggers something systemic, we expect additional strength for the U.S. dollar.
Inflation Expectations Have Risen
Trump’s proposed fiscal policies are viewed as inflationary, and thus inflation expectations have risen. Whether we end up with either stag- or re-flation will take time to ascertain, but either way, the consensus view of “lower rates for longer” is being fundamentally challenged. It is not extreme to wonder whether “good” news (re-flation) hits risk-free duration and “bad” news (stag-flation) hits credit duration.
Key considerations for emerging markets equity investors from Portfolio Manager David Semple.
EM Investment Case Still Strong
The underlying investment case for emerging markets remains strong. In the short term, uncertainty breeds risk-off behavior, particularly for an asset class such as emerging markets where growth is predicated on free movement of capital, labor, and development of global supply chains. With Trump’s victory, we question how much of his trade rhetoric will translate from the stump to implementable policy, particularly given the institutional bias of the Republican Party. Although President Trump is expected to have a relatively free hand with trade, institutional checks and balances will likely restrict his changes. On the other hand, Trump’s promise of lower taxes and deregulation are positive for U.S. economic growth and should be supportive of global consumption.
Europe and Smaller EM Countries are More Vulnerable
While we see the greatest risks to the Eurozone, smaller, more open emerging markets countries with low savings ratios may be vulnerable. Korea, Taiwan, and Japan are vulnerable given that their stock markets have high export components. India and China will be relatively less at risk. We think that the Chinese currency will continue its controlled depreciation against its trading basket, and stick to our view that a disorderly devaluation is highly implausible. As for the risk of increased protectionism, in the end, we think cooler heads will realize that the real impact of global trade barriers boils down to the increased costs of many everyday items, given that you cannot easily replace established supply chains.
Individual Companies Will Prevail
Last week’s post-election selloff of emerging markets equities does not dampen our optimism for the asset class. More importantly, we remain enthusiastic about many of the individual companies in emerging markets. We have invested through similar periods of angst and uncertainty. Recent events have helped make prices even more reasonable and attractive.
Our overall view is that the election of one particular individual does not change our long-term investment outlook. Yes, government policies are likely to change, but until these are precisely determined, our base investment case remains intact. We have also seen in the past that the investments with best year-to-date performance are hit hardest in a correction, and based on YTD 2016, this has meant gold bullion, Brazilian equities, and global fixed income.
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