A Surprise Boost for Emerging Markets
Trump’s election has provided emerging markets with an unexpected benefit: a stronger dollar, which makes foreign goods even cheaper here.
Donald Trump’s victory ignited a rally in the U.S. stock market but sent emerging-markets stocks in the opposite direction. The president-elect, however, is not solely to blame for the plight of stocks from nations such as China, Brazil, Russia and Mexico. They were in a funk even before he won.
Here are the ugly numbers: In the five-year period through Election Day, the MSCI Emerging Markets index, which focuses on large-capitalization stocks, gained just 0.9% annualized. Over the same time, Standard & Poor’s 500-stock index, the main benchmark for large-cap U.S. stocks, returned an annualized 13%. Developing-markets stocks fell in 2011, 2013, 2014 and 2015, but they were rebounding strongly in 2016 before they ran headlong into the election surprise. From November 9 through November 18, the S&P 500 climbed 2.0%, and the emerging-markets index dropped 6.4%. Is the postelection decline a sign of more agony ahead, or does the latest misery portend opportunities for contrarian investors? (Unless otherwise indicated, returns and prices are through November 30.)
Several months ago, in the July issue, I wrote a column arguing that investors don’t need to invest in foreign stocks. My point was that economies in too many parts of the world—especially developed Europe and Japan—were stagnant and that you could get sufficient exposure to the world by owning well-run U.S. companies with strong sales abroad. In general, I haven’t changed my opinion, but I do believe that emerging markets currently present a special opportunity.
Ups and downs. A little history is in order. Emerging markets were white-hot from 2003 to 2007, with the MSCI index scoring returns of at least 25% every year and producing a total gain of nearly 400%. In 2008, emerging-markets stocks plunged a sickening 53%, but within the next two years, the index rebounded and erased the losses. Since the start of 2011, however, emerging-markets stocks have cumulatively lost money.
The downturn in recent years undoubtedly has its roots in China, which represents roughly one-fourth of the market cap of the MSCI index. As recently as 2010, China’s gross domestic product was growing at a rate of 10%. Since then, the rate has declined every year, and the new normal for GDP appears to be closer to 6.5% annually. That’s not bad, especially compared with a U.S. economy that has been puttering along since the start of the millennium at about 2%, but slower growth has taken the bloom off of Chinese stocks. Look at one of my old favorites, China Mobile (symbol CHL, $55), the telecommunications giant. Its share price today is about the same as it was four years ago—and down by half from its 2007 peak. I still like it.
China’s slowing growth is part of a typical pattern. No economy grows at 10% a year (or even at 6.5%) forever. Growth slows as economies mature. Other emerging markets, such as Vietnam and Indonesia, are slowing, too, and becoming like South Korea, which is more robust than Europe and Japan but not the Asian tiger it used to be. Still, developing countries are where population in general and the middle class in particular are expanding at above-average rates. And one nation, India, is an awakening giant.
But what about Trumpism? China was a special target of Trump’s during the election campaign. Pointing to China’s trade surplus with the U.S., he said he would raise tariffs to 45% on Chinese-made goods.
In Trump’s eyes, countries that run large trade surpluses with the U.S. must be keeping the value of their currencies artificially low to make exports cheaper for American customers or cheating in some other way. Like many critics of free trade, he doesn’t seem to recognize that Americans benefit not just from exports but also from imports—which let us buy goods for fewer dollars than we would pay for domestically produced items and which also provide critical components for U.S.-made products.
So China, which in 2015 ran a trade surplus with the U.S. of $336 billion (or about 60% of the total U.S. deficit), has a big bull’s-eye painted on its back. As with many of Trump’s campaign promises, his pledge to impose huge tariffs on Chinese goods may be revised, but it’s a good bet that he will at least go after the Chinese steel and aluminum industries, which have been flooding the world with low-priced materials.
Still, it is hard to believe that trade with America’s largest partner will grind to a halt. After all, China is the third-biggest export market (after Canada and Mexico) for U.S. goods. Plus, China will almost certainly gain from the impending demise of the Trans-Pacific Partnership, the proposed 12-country free-trade agreement that was designed in part to counter the economic and military power of China. Now, some of those nations will be expanding their trade with China in response.
Chinese stocks suffered relatively little after Trump’s win. Exchange-traded iShares MSCI China ETF (MCHI, $47) dropped 5% in the 10 days after the election. By contrast, iShares MSCI Mexico ETF (EWW, $44) fell 19%.
The irony, however, is that Trump’s election has provided emerging markets with an unexpected benefit. Shortly after his victory, a rise in U.S. interest rates that began in late July started to accelerate, probably in anticipation of a widening U.S. budget deficit. The yield on the benchmark 10-year Treasury bond jumped from 1.9% on Election Day to 2.4% on November 30. That made the dollar more attractive to investors, driving down the value of other currencies. The Mexican peso fell 11% in the 10 days after Trump’s victory; the Chinese yuan and Vietnamese dong also tumbled, though not by as much. The result was to make foreign goods even more attractive to Americans by making them cheaper here.
My guess is that Trump and his team will huff and puff, but they won’t do anything that will have much impact on international trade overall. I also believe that emerging markets may offer a refuge from U.S. stocks in what may be a difficult time. David Kelly, chief global strategist for J.P. Morgan Asset Management, has warned clients that Trump’s proposal to spend $1 trillion on infrastructure and his promise to boost defense spending at a time of relatively low unemployment will lead to a widening federal budget deficit just as interest rates are rising. As a result, it’s possible that the average interest rate paid on the federal debt will return to its typical level since the 1960s (about 5%), just as the total amount Uncle Sam owes to the public (both domestic and foreign) is rising above 100% of GDP, a situation Kelly appropriately calls “fiscally reckless.”
In sum, emerging markets seem to be moving out of their bear cycle, concerns about a trade war may be overblown, and developing markets could provide a hedge against U.S. fiscal recklessness. Plus, emerging-markets stocks are cheap relative to U.S. stocks. Based on estimated 2017 profits, the price-earnings ratio for the MSCI Emerging Markets index is 15, compared with 17 for the S&P 500.
So right now, investing in emerging markets does not appear as risky as usual. Good choices are iShares MSCI Emerging Markets ETF (EEM, $36), an exchange-traded fund that tracks the MSCI index, and Vanguard Emerging Markets Stock Index (VEIEX), a mutual fund that holds about 4,000 stocks with a range of market caps. For fans of actively managed funds, I like Baron Emerging Markets (BEXFX), a member of the Kiplinger 25 that has an excellent record but a high annual expense ratio (1.45%). If you don’t own emerging markets, you should.