By Claus Born, Client Portfolio Manager for Franklin Templeton Emerging Markets Equity
Three things that we’re currently looking at in the emerging markets landscape include:
1. A win for the Republicans: The US presidential election outcome is a resounding vote in favour of the policies proposed by Donald Trump, the new president-elect. Voter concerns about inflation and immigration also played a role in his success. The implications of the election outcome for emerging markets (EMs), particularly China, are significant. The president-elect has proposed a 10% tariff on all imports, and tariffs potentially as high as 60% on Chinese imports.
2. Impact on battery packs and automobiles: There is a clear risk that the US Inflation Reduction Act (IRA) will be repealed, with negative implications for South Korean automobile and battery exporters. While US imports of electric vehicles are low, the battery packs used in domestically produced vehicles are mostly imported from Asia. Mexican auto imports into the United States are also at risk from higher tariffs. The Mexican and US auto-supply chains are closely linked, with the United States sourcing 25% of auto imports from the country. For investors, the impact of higher tariffs on US import prices—and in turn household purchasing power—is a clear concern.
3. Strength of the US dollar: The US dollar is a pro-cyclical currency, implying it strengthens when the US economy is doing well, and weakens when the economy is doing poorly. Expectations of an improved economic outlook, due to increased corporate investment related to lower taxes, imply that the dollar could strengthen. This has negative implications for emerging markets, which tend to do well in a weak versus a strong dollar environment. Nevertheless, we remain focused on company fundamentals and engaging with management teams, while acknowledging that we need to keep one eye on political developments globally.
The short-term outlook for emerging markets
Donald Trump is the US president-elect. This sets the stage for an uncertain and more unpredictable outlook for economies and markets outside the country. In our opinion, EM sentiment will likely remain weak in the near term, as investors digest the impact of Trump’s policies, particularly those relating to tariffs.
Expectations that Trump will increase tariffs on imported goods from EMs create an overhang for equity markets. If the 60% tariff threat on Chinese imports to the United States is realised, it would, in our view, result in a significant drop in Chinese exports to the United States. This would hurt China’s overall economic growth. Geopolitical considerations could also see other countries follow the United States and hike tariffs on imports from EMs as well.
Since Trump’s first term in 2016, many Chinese companies took steps to reduce the risk from higher tariffs, such as increasing exports to Asia. In our engagement with company management teams, there is some awareness of the changing operating landscape. The risk of higher tariffs is recognised and has been partially incorporated into EM valuations.
