This week, the Blackrock Investment Institute and boutique asset manager GMO both produced long-term return predictions for a range of major asset classes. While the returns the two expect are wildly different, the forecasts agree on one thing: EM equities will outperform all other assets.
In an extraordinary show of bearishness, GMO is predicting emerging market equities will be the only asset class to post meaningful positive real returns over the next seven years. But these will still be rather modest, at only 3.4% per year. Blackrock is a lot more bullish, expecting all equities to generate positive returns: expected returns for EM equities are again highest, at 7%, albeit that’s before inflation.
But it’s course possible to be even more optimistic, especially if your name is Jan Dehn, Ashmore’s head of research who vies with Franklin Templeton’s Mark Mobius for the crown of the biggest EM optimist. “EM equity returns over the next five years could be as high as 75-80%, in our view,” Dehn said in a written note published earlier this week.
Europe’s fund buyers are firmly siding with the EM bulls too. When we asked them at recent Expert Investor forums which asset class would produce the best returns over the next 12 months, emerging market equities came out on top on all occasions. At our most recent events in Iceland and Finland, more than two thirds of the audience said EM stocks would outperform all other assets.
The Trump effect
Interestingly, these same investors almost unanimously identified emerging market assets as being most at risk from a Trump presidency, when we asked them last autumn. So, what has happened in the meantime?
The simplest explanation is of course that Trump hasn’t followed through on the protectionist promises he made during his campaign. In combination with a benign macroeconomic backdrop, this has enabled emerging market assets to more than recoup initial losses after Trump indeed got elected.
But investors would be wrong to conclude any form of protectionism is now completely off the table. ‘America First’ remains the core of Trumponomics, and the beleaguered president urgently needs to shore up his support base and divert attention away from the scandals that threaten his demise. He wouldn’t be the first politician to do so by picking a fight with foreign entities, such as emerging market economies that engage in ‘very unfair’ trading practices, as he claims.
In a recent interview with The Economist, Trump promised a ‘huge’ renegotiation of Nafta and other trade agreements, vowing to reduce American trade deficits with countries such as Mexico and China ‘towards zero’. The simplest way to do that is of course by installing tariffs.
“Short-term there’s a lot of risk. Trump’s agenda, especially as it relates to trade, could be very meaningful. Big trade deals will be renegotiated,” said Bernard Chua of American Century Investments (a name that would certainly go down well with Trump), speaking at the Expert Investor Iceland forum last week in Reykjavik.
But he added: “Terms will be changed, but it will be very difficult to turn around globalisation because it’s so massive these days, accounting for so much of what we produce and consume.”
And even if Trump manages to build tariff walls, that could also bring opportunities for active managers. “Disruption in any form is both a threat and an opportunity. We focus on what types of companies it will benefit and what it is a threat to. We don’t worry too much about the idea of disruption. We like it because it feeds a lot of ideas,” said Chua.
It’s hard to argue, however, that EM companies will benefit from the disruption Chua is referring to. Benefactors are more likely to be found on the other side of the tariff walls, i.e.: in the US, or perhaps in markets not yet victimised by Trump.
Talking Fed
The other threat for emerging markets is of course a Fed rate hike. In the past, Fed monetary tightening has hit EM assets, especially bonds. But over the past few years, a strong domestic investor base has emerged, especially in Asia.
“15 or 20 years ago, companies got in trouble because they didn’t have dollar earnings and relied on foreign financing. The bulk of debt is now financed from a domestic investor base. Therefore we don’t expect short-term dislocations [as happened most recently following the Fed’s ‘Taper tantrum’ in 2013],” said Leigh Innes, an emerging markets specialist at T. Rowe Price who also spoke at the Reykjavik forum.
“It’s disingenuous to point the finger at EM,” added GAM’s Tim Love, who stressed that emerging markets are responsible neither for the global debt build-up nor for the money printing that has come to define the post-crisis financial system.
Emerging market economies indeed haven’t relied as much on central bank stimuli as their developed counterparts. But the wall of money that has reached emerging shores in in recent years has been in large part a consequence of these very policies, pushing prices of EM assets and fuelling a corporate debt binge, as EM companies took advantage of cheap access to dollar funding. Recent research by the Institute of International Finance showed that the total debt-to-GDP ratio of EM non-financial corporates is now higher than its developed market equivalent.
