Emerging Markets React Strongly To Trump Victory

| About: iShares J.P. (EMB)
This article is now exclusive for PRO subscribers.

The election of Republican Donald Trump has led to an acceleration of the trends that we discussed in our November 3 blog - Stars Align for Emerging Markets Equities. The primary trend we predicted was a downside for bonds and an upside for equities. Although both candidates promised to stimulate the economy through more infrastructure spending, Trump is likely to combine spending with tax reform and less regulation.

As markets have reacted in the past few days, what has been most surprising is the response from emerging markets ("EM"). EM currencies and bonds sold off heavily last week; this was primarily due to concerns about Trump's potential trade policies, combined with a move upwards in global rates. Here are some observations from our emerging markets investment teams.

Emerging Markets Fixed Income

Key considerations for emerging markets bond investors from Portfolio Manager Eric Fine.

China's Impact on Local Currencies in Emerging Markets

Trump has promised to name China a currency manipulator. China's currency has recently appreciated against the emerging markets currencies in its basket, creating additional devaluation pressure. Moves in this direction would be negative for emerging markets foreign exchange ("EMFX") as China is a crucial marginal buyer of commodities. China also faces some capital outflow pressures, which could be exacerbated in the event of further currency weakness or a policy challenge from the U.S.

European Fragility May Increase Volatility

Upcoming European risk events such as the Italian referendum, and the Dutch and French elections can now be viewed through the lens of the U.K.'s Brexit decision and Trump's victory. We view Europe as fragile and thus vulnerable, so political pressure could create volatility. If this volatility triggers something systemic, we expect additional strength for the U.S. dollar.

Inflation Expectations Have Risen

Trump's proposed fiscal policies are viewed as inflationary, and thus inflation expectations have risen. Whether we end up with either stag - or re-flation will take time to ascertain, but either way, the consensus view of "lower rates for longer" is being fundamentally challenged. It is not extreme to wonder whether "good" news (re-flation) hits risk-free duration and "bad" news (stag-flation) hits credit duration.

Emerging Markets Equity

Key considerations for emerging markets equity investors from Portfolio Manager David Semple.

EM Investment Case Still Strong

The underlying investment case for emerging markets remains strong. In the short term, uncertainty breeds risk-off behavior, particularly for an asset class such as emerging markets where growth is predicated on free movement of capital, labor, and development of global supply chains. With Trump's victory, we question how much of his trade rhetoric will translate from the stump to implementable policy, particularly given the institutional bias of the Republican Party. Although President Trump is expected to have a relatively free hand with trade, institutional checks and balances will likely restrict his changes. On the other hand, Trump's promise of lower taxes and deregulation are positive for U.S. economic growth and should be supportive of global consumption.

Europe and Smaller EM Countries are More Vulnerable

While we see the greatest risks to the Eurozone, smaller, more open emerging markets countries with low savings ratios may be vulnerable. Korea, Taiwan, and Japan are vulnerable given that their stock markets have high export components. India and China will be relatively less at risk. We think that the Chinese currency will continue its controlled depreciation against its trading basket, and stick to our view that a disorderly devaluation is highly implausible. As for the risk of increased protectionism, in the end, we think cooler heads will realize that the real impact of global trade barriers boils down to the increased costs of many everyday items, given that you cannot easily replace established supply chains.

Individual Companies Will Prevail

Last week's post-election selloff of emerging markets equities does not dampen our optimism for the asset class. More importantly, we remain enthusiastic about many of the individual companies in emerging markets. We have invested through similar periods of angst and uncertainty. Recent events have helped make prices even more reasonable and attractive.

Our overall view is that the election of one particular individual does not change our long-term investment outlook. Yes, government policies are likely to change, but until these are precisely determined, our base investment case remains intact. We have also seen in the past that the investments with best year-to-date performance are hit hardest in a correction, and based on YTD 2016, this has meant gold bullion, Brazilian equities, and global fixed income.

IMPORTANT DISCLOSURE

This content is published in the United States for residents of specified countries. Investors are subject to securities and tax regulations within their applicable jurisdictions that are not addressed on this content. Nothing in this content should be considered a solicitation to buy or an offer to sell shares of any investment in any jurisdiction where the offer or solicitation would be unlawful under the securities laws of such jurisdiction, nor is it intended as investment, tax, financial, or legal advice. Investors should seek such professional advice for their particular situation and jurisdiction.

The views and opinions expressed are those of the author(s) and are current as of the posting date. Commentaries are general in nature and should not be construed as investment advice. Opinions are subject to change with market conditions. All performance information is historical and is not a guarantee of future results.

You can obtain more specific information on VanEck strategies by visiting Investment Strategies.

Please note that Van Eck Securities Corporation offers investment portfolios that invest in the asset class(es) mentioned in this post. International investing involves additional risks, which include greater market volatility, the availability of less reliable financial information, higher transactional and custody costs, taxation by foreign governments, decreased market liquidity, and political instability. Changes in currency exchange rates may negatively impact an investment's return. Investments in emerging markets securities are subject to elevated risks, which include, among others, expropriation, confiscatory taxation, issues with repatriation of investment income, limitations of foreign ownership, political instability, armed conflict, and social instability.

Debt securities carry interest rate and credit risk. Bonds and bond funds will decrease in value as interest rates rise. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. Credit risk is the risk of loss on an investment due to the deterioration of an issuer's financial health. Securities may be subject to call risk, which may result in having to reinvest the proceeds at lower interest rates, resulting in a decline in income.

Diversification does not assure a profit nor protect against loss.

Investing involves risk, including possible loss of principal. An investor should consider investment objectives, risks, charges and expenses of any investment strategy carefully before investing. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of Van Eck Securities Corporation.