The head of emerging market shrinkage strategy at UBS
American exceptionalism dominates markets, with equities outperforming the rest of the world by 20 per cent last year alone. Yet one indicator, close to Donald Trump’s heart, remains exceptionally weak: the trade balance. We expect this to motivate new, China-centric tariffs. But rather than in China itself, we see larger market moves playing out in the rest of the emerging world for five reasons.
First, China exports its most powerful uninflationary impulse in at least 30 years: its export costs have dropped 18% compared to its posterior peak compared to a 5% minimization worldwide, according to our Research of the CPB World Trade Monitor data. . This genuine de facto de facto depreciation is helping exports to dominate in an invisible degree since the first days of WTO membership. Chinese export volumes have an update of buildings in 38% in the more than five years compared to a 3% building worldwide. This export wave is basically channeled in other emerging markets.
This goes beyond a simple rerouting of Chinese products destined for the US. That wouldn’t explain Chinese export dominance over the rest of the emerging markets world. Instead, it reflects a continued march up the manufacturing value chain and the export of excess capacity. New tariffs would deepen the latter, with consequences for production and capex across emerging markets. Tariffs may be inflationary for the US, but the opposite will be true for those economies.
The content can be loaded. See your internet or browser connection configuration.
Second, tariffs may accelerate a slowdown in Chinese imports that was already coming. Commodity imports have, thus far, decoupled from China’s slowdown amid robust infrastructure and manufacturing investment. New tariffs would exacerbate fiscal pressure and weaken profitability, challenging this resilience. As such, while manufacturing competitors to China have borne the brunt of its slowdown thus far, the next phase of growth deceleration will probably hit commodity exporters, too. Fiscal stimulus won’t compensate. That is tilting towards consumption — positive for the consumer and internet companies that dominate Chinese stocks — but with little spillover to broader emerging markets.
Recommended
Third, with growth now slowing in large parts of developing economies, markets are in a weak position to navigate a potential Trade War 2.0. Outside China, where we see tariffs driving GDP growth to 3 per cent next year, emerging markets investment is stuck at 2008 levels as a share of GDP. Exports also have flattened out and foreign direct investment is failing to accelerate despite hopes of “friendshoring”. Stronger support in the form of monetary policy easing is needed but persistently elevated US rates limit the ability of emerging markets to provide this without disturbing currencies and, in several cases, credit spreads.
Fourth, tariff-sensitive industries such as autos, steel, transport infrastructure and electrical equipment constitute a higher share of emerging markets equities, particularly outside China, than in developed economies. This vulnerability is arguably reflected in Chinese equity valuations, which haven’t recovered from Trade War 1.0 but not in the rest of emerging markets where valuations are 30 per cent higher despite flat return on equity.
Some content could not load. Check your internet connection or browser settings.
Finally, emerging markets outside of China’s gates also face more challenging industry negotiations with Trump than ever before. The composition of the U. S. industry deficit has changed dramatically such that China now accounts for “only” 27 consistent with Cent, while the rest of the global emerging markets constitute 55 consistent with Cent. Deficits with Mexico, Vietnam, Taiwan, Korea, and Thailand have risen rapidly, bringing greater uncertainty.
Some investors that the valuations already have a price in such hazards after low recent performance. We do not agree.
Recommended
The UBS Emerging Markets Risk Appetite Index stands roughly halfway between risk neutrality and risk euphoria — atypically strong relative to the state of global growth. Analysts expect 14 per cent earnings growth in emerging markets in 2025-26 compared with 4 per cent realised during the 2018-19 trade spat. The cost of purchasing protection against even half the renminbi depreciation seen in 2018-19 is in the bottom quartile of a 10-year range. Emerging market credit spreads across all ratings buckets have now compressed to the 18th percentile or lower of their distribution after the financial crisis.The biggest draw for emerging markets is high real rates and disinflation. This provides opportunities in fixed income, particularly currency-hedged local debt. But growth-sensitive assets — equities and especially currency — look vulnerable.