NN Investment Partners, the Dutch fund manager, changed its emerging markets positions after the US election last week due to the possibility of a rise in protectionism under the new administration.
M.J. Bakkum, senior emerging markets strategist at NN IP, said at a media briefing on Tuesday that the outflows from emerging markets had been worse than the firm expected after Republican Donald Trump won the US election on November 8.
“After the US election we moved from a small overweight to a small underweight in both emerging market local currency debt and equities,” Bakkum added.“The risk of protectionism real.”
Emerging market exporters have been struggling due to weak global trade growth and a more protectionist US policy will make it even more difficult to get back to positive export growth, which could lead to a decline in capital flows. He continued that in addition, longer-term worries over emerging markets still exist such as slower growth in China and the lack of reform in many countries, which is needed to drive domestic demand, given the high leverage and weak global trade.
Bakkum said: “We therefore have a preference for markets which do not rely too much on exports and where structural change and better policy execution are producing higher growth. We like India, Indonesia, Colombia, Argentina and Vietnam, while we underweight Turkey, Brazil, Malaysia, South Africa, Russia, Egypt, Philippines and China.”
Gene Frieda, global strategist in Pimco’s London office, said in a note that the election of Trump and Republican majorities in the US Congress represent a pivot point for emerging markets and some investors have reacted already as valuations and fund flows dropped quickly in the days after the result.
“However, the implications of the US elections for emerging markets are more nuanced,” added Frieda. “Differentiation within the emerging market asset class should persist, and the winners and losers may vary dramatically depending on which of the potential combinations of US monetary, trade and fiscal policy play out.”
Frieda laid out the outlook for emerging market assets depending on four combinations of policy that could unfold. A US fiscal policy expansion combined with benign trade policy and a dovish Federal Reserve would be the most similar to the environment today and emerging market assets would perform well generally. In contrast, the worst-case scenario would be trade protectionism and looser US fiscal policy, prompting the Fed into a more rapid response and mean returns would almost certainly be negative for the emerging asset class.
“In our view, selective investing geared to avoid the risk around the threat of protectionism, in particular, may lead to significant pockets of long-term value within the emerging market asset class,” Frieda added.
He concluded that emerging market valuations remain attractive on a relative basis and inflows have been modest compared to past cycles. “As a result, with improving external balances and weak domestic demand in emerging market countries, the traditional threat to emerging markets ‒ a sudden stop in capital flows born of a more hawkish US Federal Reserve – appears reasonably contained,” said Frieda.
Jan Dehn, head of research at Ashmore Investment Management which specialises in emerging markets, said in a note this week that the material moves in emerging market asset prices and currencies following the Trump election victory are a market over-reaction and misdirected as investors are likely to take some time to form a consensus about his policy. He recommended that emerging market investors should therefore exploit the opportunity to buy.
“We think the emerging market sell-off will soon abate and buyers will return, attracted by the sudden cheapness,” said Dehn. “We also see no fundamental reasons to be worried about emerging markets at this juncture.”
However Dehn also warned that if Trump follows through on his election promises, there are good reasons to believe that the 35-year rally in developed market fixed income is over.
“The rise in debt has also been accompanied by a sharp decline in productivity, which has contributed to a slowdown in the average growth rate across developed countries by more than 40% since 2008/2009,” added Dehn. “This means, of course, that prospects of growing out of the debt problem have deteriorated rather than improved over the period.”
In addition Dehn said emerging market government debt levels currently average less than 50% of GDP and have issued $48 trillion of liabilities, while developed countries have issued nearly $135 trillion.
“To put these numbers in context emerging countries now make up more than half (58%) of global GDP, so it does not take a great mathematical genius to work out who has a debt problem,” he added. “These are the reasons why we view the current volatility (a) as a reaction to the huge uncertainty created by Trump’s election and (b) as an opportunity.”
Ashmore expects solid emerging markets performance next year which is very similar to 2016. Dehn argued that $50bn entered emerging markets through exchange-traded funds, and is now in retreat, but emerging market bond markets alone are $18.5 trillion, so this ETF outflow is actually very small.
“As investors will recall 2016 also began with a bearish backdrop for emerging markets (the Dec 2015 Fed hike) only to deliver excellent performance,” said Dehn. “The drivers of performance in 2017 will be much the same, including high yields and good technicals, but now also accompanied by an even stronger growth premium and the fruits of deep reforms undertaken in large parts of emerging markets over the past couple of years.”
NN IP’s outlook for 2017 is that political uncertainty will be a dominant theme on financial markets but there will still be a mild improvement in global growth momentum as shifts in commodity prices and exchange rates are slowly dying out and earnings are supported by stronger global demand and higher oil prices.
The Dutch manager expects a pick-up in global nominal growth next year and a more balanced economic policy approach: less monetary and more fiscal policy stimulus, and for this reflation theme to persist in both equity and bond markets in the coming quarters.
Valentijn van Nieuwenhuijzen, chief strategist and head of multi asset at NN IP, said at the briefing: “While we live in uncertain times, it does not mean that opportunities are absent. The political uncertainty can lead to volatility, which means that a flexible investment approach is a necessity.”
Patrick Moonen, senior strategist multi asset at NN IP said at the briefing that substantial fiscal stimulus, such as Trump’s planned spending on infrastructure, favours cyclical sectors, particularly materials and financials. However yield-sensitive sectors such as real estate and utilities will be negatively impacted. Moonen continued that the geographical markets most sensitive to the reflation trade are Japan and the Eurozone.
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