The recent emerging market sell-off caused by Donald Trump’s victory in the US election will be short-lived and buyers will soon return to this year’s top-performing market, according to Ashmore’s Jan Dehn (pictured). 
The head of research also believes that, while the result has led to a short-term blip in emerging markets, it finally spells the end for developed market fixed income’s 35-year bull run.
Emerging market equities have been this year’s top-performers so far, with the MSCI Emerging Markets index more than doubling the performance of the FTSE 100 year-to-date with a 29.22 per cent return.
Performance of indices in 2016
Source: FE Analytics
Since the shock election of the Republican candidate to be the US’s next president, however, the index is down 5.51 percentage points while, perhaps surprisingly, the S&P 500 is up by 1.66 percentage points.
This could be because of the potential implementation of hefty trade tariffs on China and Mexico, as well as the fact the dollar could strengthen if fiscal policy is implemented, increasing levels of dollar-denominated debt in emerging markets.
Despite this, Dehn believes any moves in asset prices and currencies in emerging markets are an over-reaction and misdirected towards the sector.
“Markets are likely to take some time to form a consensus about America’s path under a Donald Trump presidency,” he said.
“We think the EM sell-off will soon abate and buyers will return, attracted by the sudden cheapness. We also see no fundamental reasons to be worried about EM at this juncture.
“EM investors should therefore exploit the opportunity created by irrational Trump exuberance to buy.”
The head of research says market overreactions are common when it comes to emerging markets and warns those who have decided to sell out are likely to be proven wrong. Meanwhile, those who have opted to increase their emerging market exposure and take advantage of recent volatility are likely to be “rewarded handsomely”.
He says there are several potential reasons for this. Firstly, he argues that Trump’s rhetoric of improving living standards for hard-working American families cannot be done by persecuting minorities, despite the opinions he expressed during the election campaign.
Dehn says this is because they are not the root of the problem in the first place and, in order to deliver his pledge effectively, he will have to address the economy directly. Therefore, Dehn expects his controversial views to be toned down and for his focus to shift from social to economic issues.
Secondly, he explains that political capital tends to peak for US presidents in their first term, meaning they tend to focus on domestic rather than foreign issues first and foremost.
“Foreign policy is almost always relegated to the second term, when there is no more political capital to push reforms through Congress. Trump will face the same constraints,” he said.
“Given that Trump is likely to have an extensive domestic policy agenda, we think his focus will very much be on domestic matters and not, as many think, imminent trade wars and other foreign policy related issues.
“Trump’s domestic policy objectives include whole and partial repeals of financial regulation, climate change commitments and Obamacare in addition to corporate tax reform and infrastructure spending programmes.”
Another reason Dehn expects emerging markets to remain strong over the longer term is that a rise in inflation in the context of negative real interest rates, combined with repressed long bond yields, should lead to a weaker dollar.
He says a lower dollar would help American producers versus overseas competitors and would therefore stimulate growth. As such, he believes devaluing the currency rather than starting a trade war would be the most effective way for Trump to favour American business interests.
Finally, Dehn reasons that there will be a decline in the US’s global influence under Trump, which should also be beneficial for emerging markets.
“As Trump’s America retreats from the global stage to focus on domestic matters we see China continuing to advance in Asia, while Europe will be forced, whether it likes it or not, into closer ties with Russia on account of Europe’s dependence on Russian energy. No wonder Putin strongly supported Trump during the campaign,” he said.
“Against this menu of likely policy preferences, we think the EM sell-off will soon abate and buyers will return, attracted by the fortune of sudden cheapness.
“We see no fundamental reasons at all to be worried about EM at this juncture. EM’s growth premium is improving and technicals are good. EM has proven its resilience by successfully weathering major shocks in recent years, including the taper tantrum, a massive fall in commodity prices, a sizeable dollar rally and the start of the Fed hiking cycle.”
That said, he urges investors not to rest on their laurels, given the potential ramifications the Trump victory could well have on other asset classes over the longer term.
“The market reaction to Trump’s victory may be excessive and somewhat irrational in EM, but it should be viewed as a harbinger of much larger and serious problems that threaten fixed income in developed markets,” Dehn said.
“Specifically, if Trump follows through on his election promises we see good reasons to believe that the 35-year rally in developed market fixed income is over.”
Investment-grade bonds have long been popular among investors, given their traditionally ‘safe’ reputation and their ability to deliver both steady growth and regular income.
The asset class has been particularly favoured in recent years, given that ultra-loose monetary has intensified investors’ hunt for yield and geopolitical uncertainty has prompted many to de-risk their portfolios.
Over recent weeks, however, bond yields have begun to rise and volatility has increased, which has potentially been caused by fears of inflation rising and bond yields being unable to keep up with rising costs.
Performance of indices in 2016
Source: FE Analytics
While many are worried that ultra-loose monetary policy will be unable to continue generally, Trump’s pledge to boost fiscal spending has exacerbated inflation concerns.
“The end of the fixed income rally in developed markets is obviously no trivial matter. After all, long bond yields, for example, in the US fell from an intra-year high of more than 15 per cent in 1981 to a low of just 2.1 per cent by mid-2016, negative yields in real terms. Unfortunately, consumers did not save in the face of lower borrowing costs,” Dehn continued.
“Rather, they increased spending. Since 1981 the US has doubled its debt to GDP ratio from 161 per cent to 331 per cent of GDP (more than 600 per cent of GDP if one includes unfunded pension liabilities and the present value of Medicare deficits for the next 20 years).
“The rise in debt has also been accompanied by a sharp decline in productivity, which has contributed to a slowdown in the average growth rate across developed countries by more than 40 per cent since 2008/2009. This means, of course, that prospects of growing out of the debt problem have deteriorated rather than improved over the period.”