Author:
Brian S. Freiwald, CFA | Portfolio Manager
In the runup to the US presidential election, investors focused on emerging markets (EMs) are weighing the implications of a Harris versus Trump administration. While each could bring challenges, we believe the election uncertainty presents a compelling buying opportunity in EM equities. Election polling data has oscillated in recent months, but our conviction has not—we believe the outlook for EMs remains bright regardless of who is elected in November.
Trump: Headline risk high; EPS risk low
In 2016, at the time of Donald Trump’s surprise victory in the US presidential election, I was in Mexico at a meeting with Banxico, the country’s central bank. Immediately following the election results, we saw Mexico’s currency depreciate by over 10%. It was part of a knee-jerk reaction that sent EM shares into a 6% decline for the following week. EM stocks, as measured by the MSCI Emerging Markets Index, underperformed the S&P 500 Index by 8% for that week.1 However, over the year following the election, EM stocks appreciated 30% and beat the S&P 500 Index by 6%. Equity markets in China, India, and South Korea outperformed while Mexico was a notable underperformer.
The most obvious concern related to a Trump administration is the potential for higher tariffs on goods entering the United States from trading partners, particularly China. Estimates suggest that implementation of tariffs in isolation would be a 2.5% headwind to China’s gross domestic product.2 In addition, Taiwan, South Korea, and Mexico all have high export exposure to the US economy and sensitivity to past tariff announcements from the Trump administration.
It is important to consider second-order effects, as companies will find ways to circumvent higher tariffs.”
It is important to consider the second-order effects. Companies will find ways to circumvent the tariffs. India and ASEAN3 markets should benefit from the “repackaging” of these goods as well as reshoring—businesses moving manufacturing back to their domestic markets. Notably, we believe there could be winners in China as it “retaliates” by accelerating its replacement of US businesses with domestic competitors. This could create challenges for some large US companies. Another risk that could reemerge under a Republican sweep would be a ban on Chinese American depositary receipts (ADRs) and other limits on investing in China.
A Harris win could be less disruptive
Based on eight US presidential cycles, emerging markets have historically fared better with a Democrat in the White House. The Biden administration kept the Trump tariffs in place, and we expect a Harris administration would maintain the status quo. This includes anti-China trade policies, which, right or wrong, have support from both sides of the aisle. The diversification of supply chains outside of China will likely continue, but this is a decade-long trend that is already priced in. While China remains the largest underweight position across our portfolios, we expect ASEAN, India, and Mexico to remain beneficiaries of this trend. In summary on trade, the impact of a Harris win would be less negative, but either outcome is manageable.
The diversification of supply chains outside of China will continue, and we expect ASEAN, India, and Mexico to remain beneficiaries of this trend.”
Weaker dollar is bullish for EM
Under both administrations, large US budget deficits are expected to continue putting downward pressure on the US dollar. Economists are forecasting higher deficits under Trump than Harris, and Trump has championed a policy of a weaker US dollar. From this perspective, holding all else constant, a Trump victory would be positive for the relative performance of EM equities. Regardless of fiscal policies, inflation expectations are falling fast, driving US interest rates and the US dollar lower. EM equities historically outperform in periods of US dollar weakness, which is increasingly looking like the base case.
Our bullish outlook for emerging markets extends beyond the opportunities from election volatility.”
Risk/reward in EM equities is improving
Our bullish outlook for EMs extends beyond the opportunities from election volatility. We view the broadening of market leadership beyond the Magnificent Seven4 mega-caps as positive for EM equities, which, in our view, continue to offer an attractive risk/reward profile.
EM valuations remain attractive—trading at 12x forward earnings per share (EPS) versus 23x for the S&P 500 Index, a historically wide discount.5 These valuations also come with stronger fundamentals. For the MSCI EM Index, the market is forecasting EPS growth of 17% in 2024 and 16% in 2025, outpacing growth rates in the US and other developed markets.6
Election uncertainty, a weak US dollar, enticing valuations, and impressive profit growth potential all make us enthusiastic buyers of EM equities today.
1The MSCI Emerging Markets Index captures large- and mid-cap representation across 24 EM countries. With 1,330 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country. Past performance is not an indicator or a guarantee of future performance. Indexes are unmanaged and one cannot invest directly in them. They do not include fees, expenses or sales charges.
2 Source: Bloomberg/UBS, as of 8/29/24. There is no assurance that any estimate, forecast or projection will be realized.
3 Association of Southeast Asian Nations
4 The “Magnificent Seven” are Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla.
5 Source: Bloomberg, as of 8/29/24. There is no assurance that any estimate, forecast or projection will be realized.
6 Source: Bloomberg, as of 8/29/24. There is no assurance that any estimate, forecast or projection will be realized.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal.
Equity securities are subject to price fluctuation and possible loss of principal.
International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets. Investments in companies in a specific country or region may experience greater volatility than those that are more broadly diversified geographically.
The government’s participation in the economy is still high and, therefore, investments in China will be subject to larger regulatory risk levels compared to many other countries. There are special risks associated with investments in China, Hong Kong and Taiwan, including less liquidity, expropriation, confiscatory taxation, international trade tensions, nationalization, and exchange control regulations and rapid inflation, all of which can negatively impact the fund. Investments in Hong Kong and Taiwan could be adversely affected by its political and economic relationship with China.
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