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Expect Surge in Emerging Markets, but Beware Trump Trade Risks

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Despite potential risks following Donald Trump’s presidential victory, the emerging market growth outlook looks positive for 2017.

Modest economic growth of 4.7% is expected in emerging markets, which is better than in the U.S. and the rest of the developed world, according to a Bank of America Merrill Lynch Global Research report.

India is expected to lead, with GDP rising 7.6%, while China’s bellwether economy expands by 6.6%, Merrill finds. In addition, overall emerging Asia should grow by 6.2%; Eastern Europe, the Middle East and Africa (EEMEA) should rise 1.9%; and Latin America should rebound with growth of 1.5%, after a drop in 2016.

According to Merrill, U.S. rates will likely cast a shadow over emerging markets debt, with returns of about 2.6% for external debt and 0.7% for local debt.

While emerging markets usually grow faster that developed markets, 2016 was the first year that emerging markets’ growth was accelerating faster than developed markets since 2011.

Ed Kerschner, chief investment strategist at Columbia Threadneedle Investments, thinks this could continue through 2020.

“Historically whenever EM growth accelerates faster than developed market growth, emerging markets have outperformed developed markets,” Kerschner told ThinkAdvisor. “So far we’re seeing EM outperforming developed markets this year. And we would expect that to continue into next year because of that accelerating growth.”

David Kelly, managing director and chief global strategist at J.P. Morgan Asset Management, also finds that consensus expectations in 2016 have been consistently pointing to an improvement in the emerging market growth alpha over the next 12 months, for the first time in almost six years.

“This is a trend we expect to continue picking up steam in 2017,” Kelly writes in his 2017 investment outlook. “This return of the EM growth alpha has come from a fall in expectations of [developed market] growth rates, as well as most recently from an expected pickup in EM growth itself.”

According to Kerschner, earnings growth and “reasonably attractive” valuations are contributing to this positive outlook for emerging markets.

“You’ve got expectations that emerging market earnings will – in 2017 – outperform the U.S., outperform Europe, outperform Japan,” Kerschner said.

According to FactSet consensus estimates, emerging market earnings are expected to grow by 15% in 2017. In addition, LPL Research’s 2017 Outlook cites valuations overseas, and “especially” in emerging markets, as “particularly attractive.”

Although there may be opportunities in emerging markets, geopolitical risks do suggest some caution.

Potential Roadblocks

Emerging market assets suffered following the Trump presidential victory and the Republican sweep of Congress. According to Kelly’s 2017 investment outlook, this raises the question of whether the EM growth alpha can be derailed by U.S. policy in 2017.

“Investors should remember that there is still much uncertainty around Mr. Trump’s policies over the next four years, and the impact on emerging markets will depend on the policy mix that is ultimately implemented,” Kelly writes.

The pro-growth aspects of Trump’s agenda, such as fiscal expansion and deregulation, could have positive implications for global growth as a whole, including for emerging markets. However, according to Kelly, the “very restrictive” trade and immigration policies could have negative direct and indirect effects on EM growth, especially those countries with closer ties to the U.S.

According to Neuberger Berman’s 2017 outlook, the firm became more cautious on emerging markets since the election, citing “the potential of higher U.S interest rates, a stronger U.S. dollar and tension over trade issues heightened the risk of equity and fixed income investing in the region,” according to Erik Knutzen, multi-asset class chief investment officer.

Knutzen does still belive there is a long-term case for emerging markets investment – pointing out that post-election market movements have resulted in fixed income yields and equity valuations that are more attractive than before.

While Kerschner also believes Trump’s potential trade policies could hurt emerging markets, he said it was important to understand the numbers.

“Do you know what percent of emerging market exports go to the United States? It’s down to only 16%,” Kerschner said.

However, he added, emerging market exports to other emerging markets make up about 40% of the total.

“Remember trade is a two-way street,” Kerschner told ThinkAdvisor. “Forty-six percent of U.S. exports go to emerging markets. While I understand the attractive political rhetoric of trade confrontation, economically it doesn’t really seem to make much sense.”

According to LPL Research, one of the greatest risks to any international investment is currency uncertainty.

“Immediately after the U.S. election, the dollar rallied against almost all major currencies as U.S. interest rates increased dramatically,” according to LPL Research. “Continued dollar strength, similar to that experienced in late 2014, would be meaningfully negative for all non-U.S. assets, both equity and debt, developed and emerging.”

While LPL says this is not the most likely scenario, it would prefer to see stabilization, or even a decline in the dollar, before making further investments into international markets.

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