PMC Weekly Review - December 30, 2016

A Macro View – Post Election EM Trump Dump

Emerging Markets stocks enjoyed something of a renaissance in 2016, after suffering through three consecutive calendar years in which the MSCI Emerging Markets Index dropped in value. Indeed, nobody could fault Emerging Markets equity investors for hitting the exits last year, after the three-year skid culminated in a thoroughly disappointing 2015, with a nearly 15% drop in the MSCI Emerging Markets Index. This trend reversed throughout most of 2016, until the unexpected election of Donald Trump as US President. In fact, as of the close of Tuesday, November 8, the Index was up nearly 16% during the year. Juxtaposing that return with the MSCI EAFE Index return of -1% over that span makes it even more impressive. With EM earnings turning the corner, important market and institutional reforms occurring in many emerging market countries, and attractive valuations on both an absolute basis and relative to developed economies, the turnaround appeared to have legs. However, following the US elections, the MSCI EM Index fell 4.6%, whereas the MSCI EAFE Index gained nearly 1.6%.

Digging into the numbers reveals that since November 9, each of the top 10 highest-weighted countries in the MSCI Emerging Markets Index (which account for nearly 90% of the index’s weight), have lost value, ranging from -2.5% (South Korea) to -14.0% (Mexico), with one exception. That single exception is Russia, which has gained nearly 20% since the election. Clearly, the market is expecting a cozier relationship between the next US administration and its Russian counterparts. President-elect Trump has signaled as much during the campaign and, even after his victory, as President-elect, by his choice for Secretary of State, Rex W. Tillerson. In fact, Mr. Tillerson, outgoing CEO of Exxon-Mobil, has had a decades-long close relationship with Russian president Vladimir Putin. It appears the market expects that sanctions on Russia, enacted in response to the annexation of Crimea in February of 2014, will be eased, at the very least—if not completely lifted.

Interpreting the reaction of the remainder of the emerging market (EM) countries to the election is a bit more nuanced. Trump campaigned on a platform of industrial protectionism and the unwinding of trade deals that allow products to cross borders with relatively little friction or tariffs. Given the export-oriented nature of EM economies, these proposals would present a headwind to these countries. In addition, the Fed’s tightening of liquidity conditions has resulted in a strengthening US dollar, a steepening US yield curve, and higher global interest rates. These factors have also presented a headwind to emerging markets for a variety of reasons, with the massive amount of dollar-denominated EM debt being among the biggest.

Despite the knee-jerk reaction to the US election by market participants, many reasons exist to be optimistic regarding emerging markets equity investing. First, President-elect Trump’s stance on protectionist-type policies may be more pragmatic than anticipated. With a full boat of issues facing him, he is unlikely to expend the political capital necessary to enact meaningful protectionist policies, especially in the face of congressional opposition. Second, although tightening financial conditions are a difficult environment for emerging markets, the prospect of higher US economic growth will probably outweigh them. Last, emerging markets valuation is attractive on both an absolute and relative basis. All of these factors give us confidence that the market will recognize that concerns over the fallout of the US election are overblown, and emerging markets equities will recover in 2017.

Happy New Year!

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