Jan Dehn, head of Research at Ashmore, explores the implications of the impending US elections on Emerging Markets.
Regardless of who wins the US presidential election, EM looks poised for continued outperformance due to improving absolute and relative fundamentals, higher yields and sound technicals. The short-term market dynamics may be different depending on who becomes the next US president, but we expect the winner to be inevitably and severely constrained both politically and economically.
The US election has become a major media event, but so far it has failed to move Emerging Markets (EM) asset prices very much with the sole exception of the Mexican Peso, which has become a favourite vehicle of many investors to express their views about the election outcome. EM fundamentals have been even less impacted. Still, given the uncertainty about the outcome of the election it is prudent to consider each of the two most likely scenarios. In no particular order:
Donald Trump wins: Risk aversion rises temporarily and EM may underperform in the initial market reaction. Investors should fade the sell-off immediately after the election and add EM and global HY.
Hillary Clinton wins: Solid broad-based relief rally with possible significant EM outperformance. Investors should fade the rally in the most expensive markets, that is the QE-buoyed markets, but remain long EM, which remains the better place to be invested in what is likely to be a status quo environment.
We expect that Donald Trump would have the support of the House of Representatives. He would seek to cut taxes for corporates and aim to develop more infrastructure investment. Forget the wall with Mexico and other anti-immigration rhetoric. We think the actual policy changes will be slow and less extreme than expected. Hence, you could consider buying into bouts of risk aversion, especially EM.
If Hillary Clinton wins, we expect her presidency to born under a cloud of controversy due to the email scandal, which is likely to rear its head again despite a late reprieve from the FBI. She will start her presidency as one of the least trusted presidents in history. Without the support of the House of Representatives she faces the prospect of being a lame duck from day one. She will seek to raise taxes for the rich but since she may not be able to achieve much domestically she is likely to focus on foreign policy. Investors should therefore fade the rally in heavily inflated QE-supported markets and continue to rotate into EM markets, which have much more upside potential.
EM continues to show resilience in the face of shocks
The EM fundamental and technical backdrop remains solid. The political dynamics are sharply contrasting between EM and developing countries. In the latter, rising inequality and slowing growth is fuelling populism, which in turn is feeding into even worse economic policies. By contrast, the EM growth premium is now rising, which, by easing political constraints, is generally positive for reforms and the quality of economic policies in general. EM have undertaken significant external adjustment since 2013, so most countries are now also much less vulnerable to external shocks.
EM assets continue to show remarkable resilience in the face of shocks. The US presidential election is the fourth major source of risk in 2016 which, under other circumstances, could conceivably have led to a material sell-off in EM assets, but has not (the other three examples being the market pricing in three Fed hikes back in April, the Brexit shock and the Turkish coup attempt). EM asset prices are proving resilient in the face of uncertainty due to a combination of high yields (in both absolute and relative terms) and very good technicals.
Many investors who normally buy and sell EM assets solely in response to headlines – retail, cross-over, hedge funds and banks included – are either lightly positioned or entirely out of the market. This is why there is little selling in response to risk-off events in developed economies. The remaining investors – real money – tend to buy on dips, which tends to limit the downside risks. The strong technicals also imply that should risk appetite return, there is plenty of room for upside. Returns should be far better in EM than in developed markets.