Trump’s second term in the Whitehouse has created a polarised, volatile investment landscape. In the following analysis, Jean-Charles Sambor, Head of Emerging Market Debt, TT International, highlights how this is presenting active, contrarian investors with unique opportunities in under-priced EM assets.
Donald Trump’s victory has led to much doom-mongering among economists and emerging market (EM) investors alike, with outflows from EM bond funds accelerating in the wake of the election. However, as we discuss in the following piece, there are good reasons to believe that the consensus is overlooking a number of eminently plausible scenarios, which could leave many investors wrong-footed. More fundamentally, we believe the election result is an enormous opportunity as we cross the Rubicon into a more volatile, polarised world. This investment environment will likely be characterised by increasing uncertainty, event-risk, and a divergence in performance between relative winners and losers. In short, it should suit truly active, contrarian and agile investors.
Markets appear to have taken Trump’s tariff threats at face value and concluded that this will have a material impact on inflation. However, Trump’s victory was due in part to a backlash against inflation, for which the electorate blamed the incumbent. Whereas when Trump first came to power it was deflation that kept policymakers awake at night, now it is higher inflation that is leading to politicians being unceremoniously shown the exit. Trump will be acutely aware that inflation is one of the key reasons for incumbents being voted out across the developed world. Against this backdrop, policies such as tariffs that could stoke inflation may end up being moderated. Importantly, even if Trump does implement aggressive tariffs, these can be mitigated to some degree through currency shock absorbers and companies rerouting trade.
The consensus argument runs that higher inflation will slow the pace of rate cuts in the US, a train of thought that has contributed to a stronger Dollar and acted as a headwind for EM assets. But here once again investors may be overlooking some important factors. In addition to the possibility that Trump’s tariff bark is worse than its bite and the fact that some of his agenda is disinflationary, the US has a twin deficit that makes those in most emerging economies look tame. Over time these gaping deficits will almost certainly raise the risk premium for owning Dollar denominated assets, and pressurise the currency itself.
Whilst the scenarios outlined above are based on conjecture, what seems certain is that we are entering a more polarised world that will see an increasing divergence in performance between relative winners and losers. So, which areas of the market look particularly well or poorly placed at present?
We are still bullish on duration, and believe that US Treasury yields will remain volatile but continue to tighten. We see limited scope for further tightening of EM Investment Grade spreads. However, we think that EM Debt, including Investment Grade, will generally be seen as a compelling carry opportunity for a number of reasons. Indeed, EM fundamentals continue to improve, the EM growth differential over DM remains high, whilst EM and DM are at different points in their respective credit cycles, meaning that default rates will likely fall in EM as they rise in DM. More specifically, we see potential for outsized returns in special situations in distressed Asia credits, selective African frontier markets (especially Ghana and Senegal), Sri Lanka, and other special situations such as Venezuela and Lebanon. Conversely, we believe that parts of the EM High Yield market are now relatively frothy and crowded, and we are therefore being increasingly selective in the BB/B+ category. Given the aforementioned potential for the US Dollar to weaken in the medium term, we have a positive bias on EM FX and will continue to play this tactically, given the expected upcoming volatility. We are particularly positive on various currencies in Asia – especially South East Asia – and LatAm. Finally, we expect increased dispersion in local rates. We believe that high volatility in Brazilian rates should provide alpha opportunities, and are confident that inflation will remain under control in the rest of LatAm. We expect South East Asian central banks to be able to cut rates further, which should prove positive. However, we remain sceptical that long-term yields can continue to fall significantly in China, and we expect to see increasing divergence in CEEMEA after a significant rally in local markets.
In a world that is increasingly polarised and volatile, pragmatism and agility will be key to success, while passive and inflexible approaches to managing EM assets are unlikely to work well. We focus on under-researched, mispriced markets, aiming to identify behavioural biases or market ‘blind spots’, where certain scenarios are overlooked because of entrenched beliefs. Indeed, emerging market assets often trade as though an outcome is almost certain, with investors crowding together in consensus positions that can be exploited – now more than ever. Trump is not a conventional president, and we believe our unconventional approach offers the perfect fit for this new investment paradigm.
