Should you worry about the EM consensus?

Added 22nd May 2017

There seems to be an investor consensus that EM stocks will continue to outperform both in the short and medium term. But what does that say about the absolute returns to be expected, and how should investors assess the dual threat Donald Trump and Fed rate hikes?

Should you worry about the EM consensus?

This week, the Blackrock Investment Institute and boutique asset manager GMO both produced long-term return predictions for a range of major asset classes. While the returns the two expect are wildly different, the forecasts agree on one thing: EM equities will outperform all other assets.

In an extraordinary show of bearishness, GMO is predicting emerging market equities will be the only asset class to post meaningful positive real returns over the next seven years. But these will still be rather modest, at only 3.4% per year. Blackrock is a lot more bullish, expecting all equities to generate positive returns: expected returns for EM equities are again highest, at 7%, albeit that’s before inflation.

 

But it’s course possible to be even more optimistic, especially if your name is Jan Dehn, Ashmore’s head of research who vies with Franklin Templeton’s Mark Mobius for the crown of the biggest EM optimist. “EM equity returns over the next five years could be as high as 75-80%, in our view,” Dehn said in a written note published earlier this week.

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Europe’s fund buyers are firmly siding with the EM bulls too. When we asked them at recent Expert Investor forums which asset class would produce the best returns over the next 12 months, emerging market equities came out on top on all occasions. At our most recent events in Iceland and Finland, more than two thirds of the audience said EM stocks would outperform all other assets.

"It will be very difficult to turn around globalisation because it’s so massive these days" - Bernard Chua

The Trump effect

Interestingly, these same investors almost unanimously identified emerging market assets as being most at risk from a Trump presidency, when we asked them last autumn. So, what has happened in the meantime?

The simplest explanation is of course that Trump hasn’t followed through on the protectionist promises he made during his campaign. In combination with a benign macroeconomic backdrop, this has enabled emerging market assets to more than recoup initial losses after Trump indeed got elected.

But investors would be wrong to conclude any form of protectionism is now completely off the table. ‘America First’ remains the core of Trumponomics, and the beleaguered president urgently needs to shore up his support base and divert attention away from the scandals that threaten his demise. He wouldn’t be the first politician to do so by picking a fight with foreign entities, such as emerging market economies that engage in ‘very unfair’ trading practices, as he claims.

In a recent interview with The Economist, Trump promised a ‘huge’ renegotiation of Nafta and other trade agreements, vowing to reduce American trade deficits with countries such as Mexico and China ‘towards zero’. The simplest way to do that is of course by installing tariffs.  

“Short-term there’s a lot of risk. Trump’s agenda, especially as it relates to trade, could be very meaningful. Big trade deals will be renegotiated,” said Bernard Chua of American Century Investments (a name that would certainly go down well with Trump), speaking at the Expert Investor Iceland forum last week in Reykjavik.

But he added: “Terms will be changed, but it will be very difficult to turn around globalisation because it’s so massive these days, accounting for so much of what we produce and consume.”

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