The election of Donald J. Trump as the 45th President of the United States on November 8th was a surprise to global financial markets, including the Emerging Markets. While United States equity valuations and the USD subsequently surged on an optimistic interpretation of Trump’s planned fiscal expansion, many other global markets felt the opposite reaction. In reality, Trump’s priorities upon taking office in January 2017 still remain to be seen, as does the extent to which Trump’s campaign rhetoric was political posturing (e.g. building a wall, be-friending Russia, renegotiating trade agreements and attacking political corruption). Hence, it is crucial to keep these initial market reactions in context as pure speculation on the basis of campaign headlines. Part of the reason Trump’s policy agenda is so hard to predict is that his campaign promises were so far-reaching in scope and untraditional in approach. Even with a Republican majority in the House and Senate, Trump’s Cabinet and advisory team composition is still a mystery and the market has little to lean on in forecasting the Trump Effect. We find it likely that Trump will make his initial push in the domestic arena, particularly around healthcare and immigration reform, which we expect to have less of an impact on the global macro-economy. However, we’d like to take this opportunity to comment on the market moves to date with a particular focus on positioning in our Emerging Markets portfolio.
In its most basic form, Trump’s plans for fiscal expansion and tax cuts are likely to drive up inflation in the United States, which led to a near-immediate rise in bond yields and steepening of the yield curve post-election. Additionally, the prospect of a Fed rate hike in December looks all but certain. Global debt and equity fund flows have chased this higher-growth economic picture in the United States at the expense of international markets, and particularly those Emerging Markets referred to colloquially as the “carry trade”. Carry trade countries are characterized by high interest rates and any decrease in the spread offered between these rates and those of perceived safer markets makes investments in these countries appear less attractive. Due to their dependence on foreign capital for funding via current account deficits, these countries also trade with a higher Beta and the reversal of the carry trade has been especially jolting. The carry trade reversal has pressured the local currencies of many of these countries that are perceived to be most negatively impacted such as Mexico, South Africa and Turkey. In addition to the equity price translation effect of FX depreciation, companies may have directional FX impacts on their individual balance sheets or operations. For example, exporters’ competitiveness and profitability is helped by currency depreciation, while companies choosing to finance themselves in foreign currency are hurt as they face unanticipated increases in interest expense. In our Emerging Markets portfolio, we feel we are well insulated from shifts in the carry trade given our underweight exposure to those countries that may potentially be worst impacted, in addition to the positive benefit to our holdings in export companies that benefit from a weakening local currency.
However, here we find it vital to differentiate between industries in which the United States has a realistic chance of successfully “on-shoring”, and those in which technology or cost structure would make it prohibitive to produce domestically.
Trump campaigned on a platform of trade deal renegotiation and unilateral protectionist measures, despite the fact that protectionism has a track record of slowing growth, restraining innovation and raising prices for consumers. Companies operating in Mexico and China are most likely to feel the impact of tariff barriers. Trump will also have the individual authority to raise tariffs on certain categories of goods, which could threaten other exporters to the United States and may precipitate a trade war. However, here we find it vital to differentiate between industries in which the United States has a realistic chance of successfully “on-shoring”, and those in which technology or cost structure would make it prohibitive to produce domestically. While the former group includes Mexican auto and white goods manufacturers, we see Taiwanese technology companies as fundamentally better protected because of the technology and capital investment which would be required to replicate their businesses in the US. In case of a trade war, opportunities may arise for other countries to pick up the slack with former US trade partners, and we expect foreign governments and companies to be on high alert for such developments. A further byproduct of Trump policies on Emerging Markets is the President-elect’s stance on domestic fossil fuel production. The stark pivot towards increasing US energy independence, reducing renewables subsidies, and mitigating regulatory intervention implies increasing US production. Hence we expect it to be more difficult for oil and gas prices to break through their current levels. However, base metals prices may benefit more broadly if a successful growth and infrastructure plan were to be executed in the United States. These combined factors would lead to continued budgetary pressure on oil exporters such as Saudi Arabia, Venezuela and Nigeria, while Russia and Brazil would be cushioned given their more diversified resources.
We would also regard Russia as one of the potential winners of a Trump presidency more generally.
We would also regard Russia as one of the potential winners of a Trump presidency more generally. In particular, we see the upside from a loosening of sanctions due to improved relations with Russia as a material upside factor for the economy which stands in stark contrast to the potential increase in protectionism that might negatively impact other EM countries. Other winners include the global defense sector, as we expect that Trump’s push to offload defense responsibilities onto allies may result in a pickup in global sector spending. Also, exporting companies with defensible market positions and competitive cost structures should ultimately prevail despite short-term anti-trade noise. We anticipate that the Value style will outperform Growth in EM, as rising interest rates deflate the unrealistic valuation multiples of many EM growth stocks. Finally, we consider the dividend-paying companies we own to be particularly well-positioned vis-a-vis EM bonds. While EM countries with weak external balances and current account deficits are likely to face rising sovereign borrowing costs in the face of a strengthening USD, the companies in our portfolio have significant financial strength and are fundamentally well positioned due to the strength of their operations and management teams. Regardless of Trump’s ultimate policy agenda, we expect these attractively-valued firms to reward us with a strong and growing stream of dividends.
Rahul Sharma – Portfolio Manager