Barometer: Emerging market assets offer refuge from Trump tariffs

Asset allocation: Trump policies give emerging markets the upper hand

Financial markets risk losing their bearings. Primarily because the world's two largest economies appear to be heading in opposite directions. 

In the US, economic prospects are uncertain. Donald Trump’s policy announcements in the first 10 weeks of his administration - which include 25% tariffs on US auto imports and an aggressive crackdown on  immigration – have proved more far-reaching than many economists and investors had anticipated. The measures will likely be stagflationary - for the US, mainly, but some other advanced economies too. All of which isn't particularly encouraging for the stock and bond and markets of the developed world. 

By contrast, China may be finally coming out of the doldrums. While US tariffs have negative effects on Chinese growth, Beijing’s
coordinated monetary and fiscal stimulus – estimated to be nearly RMB5 trillion, or more than 3 per cent of GDP -- seems to be bearing fruit. This is most evident in the housing market, which is crucial for the country's recovery, but also in consumption figures, which rebounded by more than 15 per cent on an annualised basis in the final three months of 2024.

A recovery in China has helped lift other emerging economies, which are also benefitting from falling inflation, easing monetary policies, and a weaker US dollar.

Taking all this into account, we see more opportunities in the emerging world than in developed countries. Although we are neutral across stocks, bonds and cash, we have overweight positions in emerging market debt and equities, including Chinese stocks. 

Our overweight stance on gold remains unchanged, which we see as a  hedge against volatile and unpredictable market moves.

Our business cycle analysis shows the US economy’s growth will likely slow to a below-potential rate of 2 per cent by the end of this year from 2.8 per cent last year.  The soft data we monitor is in keeping with that projection. 

Capital spending plans are subdued as businesses delay investment until they get certainty on the White House’s tariff policy. US Consumers and investors,  meanwhile, are no more positive - the former are pessimistic about their future earnings prospects while the latter have turned increasingly bearish on the outlook for American stocks (Fig. 2)

That said, the deterioration has yet to turn up in hard data and the economy is likely to find some support from further interest rate cuts from the US Federal Reserve; we expect two more cuts of 25 basis points – one in June, the other in December. 

By contrast, we are ever more optimistic on the economic outlook for China which we now think will grow 5.2 per cent, above the potential rate of 4.7 per cent and the consensus of 4.5 per cent.¹

Industrial production is growing at an six-month annualised rate of 8.8 per cent, well above the pre-pandemic six-year average of around 6 per cent.

The country’s leading indicators, which are highly correlated with GDP, have improved for four months in a row. The housing market is showing signs of stabilisation. After a decline of about 60% since its peak in the first quarter of 2021, demand for residential space has increased nearly 3 per cent year on year, while prices for new homes have stopped falling after 18 months of contraction.

We expect the People’s Bank of China to ease monetary policy further at a time when the government is ramping up fiscal stimulus.

Elsewhere, economic prospects for the euro zone have improved markedly after Germany and the EU announced plans to spend EUR800 billion and EUR500 billion respectively on defence and infrastructure.

Our calculations show this will lead to an increase in German growth of 1 per cent per year for the next three years, which could more than offset the impact of the US’s announced tariffs on European imports.  Growth should be further supported by the lagged effects of the European Central Bank’s six interest rate cuts since mid-2024.

But not everywhere in Europe is a bright spot. 

The UK economy, meanwhile, looks to be deteriorating again. It has suffered a drop in industrial production and construction activity while consumer and business surveys offer few reasons for optimism.  The Bank of England is likely to cut interest rates twice this year.

Our liquidity model continues to show the world is in the midst of sustained cycle of monetary easing: 23 of the world’s 30 major central banks are cutting interest rates.

In the US, private sector borrowing is gaining pace, just as Treasury Secretary Scott Bessent warned of a “detox” period as the government moves to cut spending. This justifies our view that the Fed will cut twice, instead of once, this year, to support the economy during this delicate period of rebalancing in borrowing from the public to private sector.

Our valuation analysis shows emerging market equities remain attractive on a price-earnings basis, while other regions have become more expensive relative to the US after a sell-off on Wall Street. 

Technical signals are neutral for both equities and bonds. Interestingly, European stocks attracted their largest four-week inflows in eight years, and the signs are that the repatriation of investments from the US to Europe could continue.

Equities regions and sectors: Chinese stimulus trumps tariffs

An improving domestic macro-economic backdrop that comes courtesy of successive rounds of fiscal and monetary stimulus, prompt us to upgrade Chinese equities to overweight.

Beijing’s efforts to put a floor under the domestic property market and to stimulate investment and consumer demand are beginning to bear fruit. Construction activity is picking up and the pace at which real estate prices are falling has slowed. And even if retail sales and real consumption spending are well below their pre-pandemic levels, both are edging higher.

Market sentiment indicators show that, for now, equity investors expect these positive domestic factors to offset risks posed by Trump’s tariffs – both those he has delivered and those he has threatened. Chinese authorities have scope to take further measures to offset additional economic onslaughts from the Trump administration. For instance, more interest rate cuts from the  People’s Bank of China, which has shifted its official monetary policy stance from ‘prudent’ to ‘moderately loose’ for the first time since the global financial crisis, could serve as a useful safety valve.

A stronger China also reinforces our overweight in emerging market equities, which also offer attractive valuations and have shown themselves to be resilient to the policy uncertainty rippling out from the US. That’s underpinned by their strong growth fundamentals: we expect emerging economies to grow 4.3% this year, compared with just 1.6% for developed economies. 

The upgrade to China contrasts with some of our caution about developed market stocks. This caution is underscored by the relative derating of the powerhouse stocks of the past couple of years: the so-called Magnificent 7 (see Fig. 3). 

We downgrade European equities to neutral. Although the market has been enthusiastic about the new Germany government’s massive fiscal package, we think the effects will be spread over a number of years and as a result won’t have immediate near-term benefits for equities beyond those already priced in. What’s more, we don’t subscribe to the idea that the EU and the US economies are decoupling. A US slowdown – albeit a benign normalisation rather than anything more sinister – would ultimately weigh on EU equities as well. As a result we prefer a neutral stance on both US and European equities.

We maintain our sector stances. We remain overweight communication services, where valuations have turned more attractive for the exposure to secular growth themes such as the adoption of artificial intelligence. We also remain overweight financials, which will benefit from continued strong earnings leadership and from expectations that Trump will ease regulation on the sector. Financials valuations despite their strong run aren’t overly rich. Finally, we remain overweight utilities, which uniquely offers both defensive characteristics strong structural growth of electricity demand.

Fixed income and currencies: Advantage emerging markets

In fixed income, the stars are aligning for emerging market bonds. Our analysis shows that each of the five macroeconomic factors that have the greatest influence on the asset’s classes returns are moving in its favour. The performance of emerging market debt has historically been determined primarily by domestic interest rates, growth differentials between emerging and advanced economies, global trade volumes, and moves in the US dollar and commodity prices. Of those, the first three are currently very supportive, and the remaining two are neutral but turning positive.

Interest rates across the emerging world are at some of the highest levels seen over the past two decades, but rate cuts are on the cards, which presents an attractive entry opportunity.

Growth differentials are also positive for emerging markets. We expect emerging economies to grow above potential this year, widening the growth gap versus their developed peers to 2.7 percentage points this year from 2.5 percentage points in 2024. Global trade has also been improving; we expect import tariffs imposed by the US to redistribute trade among countries across emerging market rather than cause a decline in global commerce. 

The dollar has eased a little from extremely overvalued levels, and we see more structural weakness over the medium term. That would mean lower burden from dollar-denominated emerging market borrowing, as well as more inflows into emerging assets and the potential for foreign investors to capitalise from currency fluctuations.

Commodity prices, meanwhile, should reap the benefits of a recovering in global manufacturing – and in China – a positive for resource-rich nations, many of which are emerging markets.

Taking all this into account, we believe the prospects for emerging market fixed income are improving, and therefore retain an overweight position across both local currency denominated government debt and corporate bonds.

We also see potential in European high yield bonds, anticipating benefits from additional interest rate cuts in the euro zone. A sharp pick-up in earnings expectations for European companies (in contrast to reversal in those for US) also bodes well for the asset class.

Conversely, we retain an underweight on Swiss bonds due to expensive valuations and limited potential for lower front-end rates, given the market is already pricing in close to negative rates.

Elsewhere, we have chosen to take profits from an underweight stance on European government bond, moving to neutral after the recent sharp rise in yields. The euro zone’s EUR800 billion fiscal stimulus package and Germany’s infrastructure and defence spending plans should support the region’s economic growth, but we believe markets are becoming overly optimistic. We expect growth of 1% this year, broadly in line with both consensus and potential.

We also turn neutral on US Treasuries, where yields now match our one-year forward fair value estimate of 4.3%, as well as trend nominal GDP growth (see Fig. 4). Despite the US administration’s renewed focus on fiscal prudence, bond yields are unlikely to fall much further in the short run given that the prevailing fear of a slowdown is overdone in our view. 

We continue to hold an overweight position in gold, which benefits from a structural and price-insensitive demand from emerging market central banks. It is also proving to be far the most consensus hedge against a possible trade war.

Global markets review: Trump shock

Global equities fell sharply in March as concerns intensified over the health of the global economy. US President Donald Trump’s tariff policies proved far more aggressive than many had anticipated, fanning concerns the US might soon witness a period of stagflation. 

Gold was a star performer of the month as it rallied nearly 10%
to hit an all-time high; the precious metal attracted demand from investors concerned about the global trade war and geopolitical tensions in Europe and the Middle East.

US stocks fell nearly 6% and were among the weakest of all markets. Having hit an all-time high in mid-February, the S&P500 index suffered the steepest quarterly loss in three years as investors unwound so-called Trump trades. Megacap technology stocks were among the hardest hit with a decline of nearly 6%, while consumer discretionary stocks also came under pressure. Utilities was the only sector that ended the month in black, thanks to its defensive qualities.

The US’s major trading partners fared no better with stocks in the euro zone, UK and Japan all losing ground in the month as worries grew over Trump’s increasing trade rhetoric.

On a quarterly basis, however, European stocks outpaced their US counterparts by the widest margin on record, or some 17%. That move (see Fig. 5) testified to the fact investors are now more attracted to undervalued European stocks over their expensive US counterparts, especially as Europe's defence spending plans are likely to support growth in the continent.

While developed markets struggled in March, most emerging markets performed  better, with Latin American and eastern European stocks rising between 2-3%.

Bonds outperformed equities, ending the month only slightly lower. US
Treasuries edged higher as expectations grew that the Fed would need to support growth with more interest cuts especially as the government reigns in spending and borrowing. European, Swiss and Japanese government bonds ended the month down. Emerging local currency bonds gained some 1.5%, benefiting from a generally weak dollar, while hard-currency debt fell almost 1%.

In credit, both investment grade and high yield debt fell on both sides
of the Atlantic as investors shunned risky assets. When it came to currencies, the dollar fell over 3%, performing particularly poorly against the euro, sterling and Russian rouble.