Emerging markets’ unexpected outperformance after “liberation day”

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Good morning. We finally had a calm day in markets. The S&P 500 was down less than 0.2 per cent yesterday. Most sectors fell, but only by a little, while info tech and a mix of defensives saw modest rises. How long will that last? Rob is off on holiday, so email me instead: aiden.reiter@ft.com.

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Emerging markets

Unhedged had suspected that emerging market equities would be hit especially hard by Trump’s “liberation day” tariffs. More than half of Trump’s so-called reciprocal tariffs were on EMs, and EM equities tend to underperform in broader risk-off environments. The strongest EMs, particularly tech-heavy countries in south-east Asia, were hit with some of the highest tariffs. And EM assets tend to strain when the dollar strengthens — which, we were told, would happen after US tariffs took effect. 

That turned out to be wrong. While both the MSCI emerging markets index and the MSCI emerging markets index excluding China fell hard in the first few days after the tariffs, MSCI emerging markets ex China did not fall as sharply as the S&P 500. And both have outperformed the S&P 500 since April 2:

There are a few potential explanations. While the market’s fall immediately after “liberation day” was a risk-off event, the storm was most severe in the US. That may have been from investors locking in their gains from years of US outperformance. Or it could have been emblematic of something worse — a flight from American capital towards other countries’ assets, as suggested by the fall of the dollar alongside rising Treasury yields.

Trump’s “reciprocal” tariffs — and his eventual pause — was also a positive surprise for some EM investors. There was already some EM weakness priced in going into “liberation day”; according to the Institute of International Finance, portfolio flows to emerging market equities fell sharply in March — particularly flows to China ($9bn outflow), but also flows to most other EM countries. However, with the exception of China, EMs have not been the focus of Trump’s policies, or so says Thierry Wizman of Macquarie Capital:

By dint of luck [such as not having big car industries], or because they have low trade with the US, many EMs — particularly in Latin America — got off pretty well after “liberation day” . . . That they are really off of Trump’s radar screen is perceived as a net benefit by investors.

Though the EMs in China’s periphery such as Thailand, Cambodia and Vietnam were hit particularly hard, Trump’s 90-day pause and his exemption of electronics tariffs has given those countries’ equities a boost, at least for now.

But, as is always the case with diverse EMs ranging from developed economies such as Taiwan to relatively poor countries such as Nigeria, there has been a range of outcomes. The outlooks have differed, too — and have changed radically since Trump paused his ‘reciprocal tariffs’, and doubled down on China.

Some countries stand to benefit from the growing rift between the US and China, and their equity indices have been lifted further by Trump’s recent focus on Beijing. Indian manufacturers hope to fill the void of cheap goods flowing to the US, and countries such as Brazil and South Africa can satiate some of China’s demand for non-US agriculture.

Others may struggle if China languishes. For example, equities in countries in Latin America that rely on Chinese investment — including Peru and Argentina — have either fallen or just barely beaten the broader emerging markets ex-China index since Trump’s reversal. And with falling oil prices and what many fear will be slowing global energy demand, oil exporters such as Saudi Arabia have underperformed:

But, broadly speaking, EM equities look better positioned than we would have expected. The picture is similar for fixed income. Spreads between emerging market bonds and safer assets have widened only modestly since the middle of March. Meanwhile, US high-yield spreads have stretched dramatically, indicating a bigger sell-off of riskier US debt than EM bonds:

It is tempting to say that EM strength — on both the equity and fixed-income sides — is a sign of the end of American exceptionalism. Indeed, many EM countries have benefited from the falling dollar, which has strengthened their currencies in comparison and made it easier for sovereigns and local corporations to service their debts. And the pick-up in US high yield, above and beyond EM spreads, is particularly concerning. 

But Unhedged will not go that far yet. Though EM outperformance could be a sign of shifting global capital flows, equity outperformance has been marginal and varied, and we still do not have the full flows data from the first half of April. And other indicators of a shifting global regime have not been strong enough to draw any conclusions: US Treasury auctions have been fine, and we have not seen other obvious signs of a drawback by foreign buyers.

On the EM fixed-income side, as William Jackson at Capital Economics notes, there is also a lot of variation:

[Spreads for] major EMs [have only widened] around 10 to 20 basis points since ‘reciprocal tariffs’ were first announced; they’ve risen further in some oil producers (Gabon, Angola, Iraq) and some EMs where concerns over debt distress are high (Bolivia, Kenya, etc)

And some of the gap between spreads in the US and EMs is down to divergent paths for monetary policy. Various EMs have successfully tamed inflation, and are likely to cut their policy rates in the coming months to fight off a potential global slowdown. Meanwhile, the monetary policy outlook for the US remains unclear. 

We are still in the early stages of the post-“liberation day” fallout, too. ‘Reciprocal tariffs’ — or something more dire — could still be applied to imports from EMs after 90 days, making them worse off by comparison.

Trump’s tariffs also matter more for the US than they matter for most EMs; US businesses are dealing with uncertainty on all fronts, whereas EM companies and sovereigns are just contending with potentially slower growth and their changing relationship to the US and China. More clarity in the US — and lower tariff barriers (we hope) — could lift American assets again.

One good read

ADHD.

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