Market Memo: Don't count out EM

12-01-2016

It’s too easy to be pessimistic about emerging markets (EM) right now. With President-elect Trump’s rhetoric against trade, growing potential for inflation and the likelihood of a faster-paced Federal Reserve, it’s not hard to see why EM investors are concerned. But this is no time to rush to judgment. Certainly, rising inflation expectations, and the increase in U.S. Treasury term premia that follows, will dictate the present. But is the recent soft patch in EM actually just that: the present? In other words, is this short-term disruption in emerging markets a long-term value buying opportunity? We believe so.

Months before the U.S. election, economic growth already was beginning to percolate in a host of emerging countries. These developments simply did not disappear into thin air after the election; rather, they were drowned out by the endless barrage of Trump policy headlines. In fact, President-elect Trump’s economic policy itinerary has the potential to increase domestic aggregate demand, historically very positive for EM growth.

Prior to the election, we saw signs, albeit slow and shaky, of improvement in China. The stimulus initiated late last year has helped, and it is likely to continue into China’s next party congress, scheduled for fall 2017. In Russia, green shoots are emerging. And there have been positive leadership changes in Brazil and Argentina.

Fast forward to today. Trump’s vow to renegotiate trade agreements and to consider tariffs undeniably have the potential for international volatility. Inflation is another fear, especially if U.S. rates rise too quickly (we all remember 2013’s taper tantrum).

Looking a little deeper, however, some positives become apparent. In the short term, Trump’s economic plans might benefit EM if more fiscal spending and tax cuts boost U.S. growth. Effectively, an increase in U.S. economic activity should ultimately benefit the mostly export-driven EM economies.

Even the most worrisome risks may not be as damaging as first thought. Trade talks will take months to settle, and we think they will be less onerous. Even the short-term pain of rising rates could lead to long-term growth down the road. In our view, consensus negativity on EM may be overdone and investors should potentially consider a contrarian, value-driven approach.