In addition to renewed trade tensions between the US and China, political tensions in Asia have risen (China versus Hong-Kong, Japan versus South Korea, India versus Kashmir) and have triggered a rise in risk aversion for emerging assets. The results of primary round elections last weekend in Argentina was also a negative surprise and could put the IMF's bailout at risk. The political situation in Argentina, nevertheless, has a limited regional spill over risk. As a result, equity markets have declined by around 8% since July while emerging debt spreads have started to widen and emerging currencies been weakened globally.
Taking place against a background of depressed global trade and manufacturing activity, these tensions are making downside risks more serious, in Asia in particular. While latest economic releases were better oriented in China, with consumption and SOE investment picking up, new tariff hikes by the US, if implemented, would add to the manufacturing sector's woes. Donald Trump's tweets remain unpredictable, and uncertainty and unpredictability weigh on investment and economic growth perspectives. At the same time accommodation by central banks mitigates the cyclical risk.
In our core scenario, the Chinese government will ease policies further and probably allow a managed depreciation of the currency to reach around 6% growth in 2019-2020. Trump's incentive to strike a deal will increase as the deadline of next year's election approaches. Therefore, we continue to believe that as long as Donald Trump does not overestimate the resilience of US economy, we should benefit from a "Trump" put and a "Fed" put. This should also help Asia and emerging markets globally to find a floor.
Neutral stance on emerging equities
In our asset allocation, we have kept a neutral stance on emerging equities and will increase our exposure when we find a better risk reward. A signal that China's economy is able to find a trough and start to send turnaround signals would also make us more comfortable with higher exposure.
The current P/E 2020 multiple is at less than 11 for the MSCI emerging markets, so even if earnings expectations are revised down for the next 12 months, the equity risk premium is already priced in. The equity market is flat year-to-date and is underperforming the US market by 15%. We have also kept our exposure to emerging debt (mainly in hard currency) which has one of the most attractive carry in our bonds' universe.
Nadège Dufossé is head of Asset Allocation at Candriam