Those countries with the strongest trade links to the United States could suffer from any potential protectionist measures put in place by the Trump administration. Globally, emerging equity valuations are still very attractive compared with their developed counterparts.
After five tough years for emerging countries, marked by a drop in world growth rates, the 2016 financial year saw the situation stabilise, with emerging GDP growth reaching 4.2% (vs. 4.0% in 2015). In 2017, GDP growth should come in at 4.6% – a level not seen since 2014. The upturn in commodities partially explains this improvement in the situation, which was marked, among other things, by an end to the supply glut. Brazil and Russia are coming out of recession and China’s economy is showing a certain amount of sturdiness. PMI indices are up. Consequently, emerging countries entered 2017 with confidence, despite the still-real threat of protectionist measures being put in place by the new Trump administration. A less open US economy would penalise emerging markets and could generate volatility, but these markets have got strong enough fundamentals to withstand any storm Trump might whip up, which in turn should create investment opportunities if the markets drop. Of the emerging markets, only Mexico could see its economic situation deteriorate sharply this year, as a result of its extremely close links with its US neighbour.
Emerging equities estimated to shed 25%-30% of their value
Since 8 November, the date of Donald Trump’s election, emerging equities have lagged slightly behind global equities, although they have partially made up some of this lost ground. If protectionist measures were to come into force in the United States, it would be those emerging countries with the greatest exposure to the US economy that would suffer the most.
Consequently, Mexico could see its situation worsen sharply as a consequence of its geographical closeness and economic links to the world’s greatest economic power. Taiwan, Mexico and India have the biggest number of significantly large companies with a direct exposure to the United States. Technology is the most exposed sector, while financials have very little direct exposure. However, while the spectre of protectionism is looming large, emerging companies’ earnings estimates are holding up well for the moment, and, in contrast to previous years, these have not been revised downwards.
Further, the fall in value of emerging equities remains significant at between 25% and 30%, depending on the ratios, and emerging currencies have once again become much more competitive against the dollar since 2011, which is a positive for these countries’ export economies. For example, the Shiller P/E ratio, which takes the average earnings over the last ten years into account, currently stands at 12 for emerging equities, compared with 29 for the US market.
Although the upturn in emerging markets may be accompanied by reflation in assets and the emergence of inflationary risks, bond investments should be considered. Consequently, thanks to shorter durations (interest-rate sensitivity), corporate debt in external currencies, will not suffer as much as the Fed tightens its monetary policy. In the emerging debt universe, emerging corporate bonds should be favoured, as they offer shorter durations and higher risk premiums than emerging countries’ sovereign debt.
As political risk is now at the same levels – if not higher – in developed countries as in emerging ones, the latter should be favoured by investors.
Denis Girault
Head of Emerging Markets Fixed Income
Mathieu Nègre
CFA, Head of Global Emerging Equities
Koon Chow
Senior Macro and FX Strategist - Emerging Markets Fixed Income