Emerging markets under Trump 2.0: expect the unexpected

We believe Donald Trump’s return to the White House is an opportune moment to take stock of what we’ve learned as emerging markets investors during his first term. Events could unfold in a different direction than markets currently assume, given President Trump’s inherent unpredictability, but we believe that revisiting the outcomes of his first administration can help prepare for the unexpected.

Counterintuitively perhaps, emerging markets (EM) posted positive results under President Trump’s first term, achieving 13.6% annualised growth compared to 14.0% for the MSCI World Index.¹ While this positive scenario may not repeat itself, several factors give us cause to be constructive over the longer term, notably: 

• After strengthening initially, the USD declined, providing key support to EM outperformance. Today, the combination of higher tariffs, export controls and deportation policies that Trump advocates is likely to fuel inflation, which could result in higher interest rates and a stronger currency. However, these proposed measures are also in conflict with Trump’s wish to close the US’s trade deficit with key trading partners which would require a more attractive USD exchange rate. Resolving this dilemma may result in a similar USD trajectory this time round.
• Tariff increases ended up being more modest than initially feared. Average US tariffs on all trading partners increased from 1.5% to 3%. Disruption levels were high, with China facing a 17% hike in tariffs. Despite this steep increase, China’s trade surplus with the US grew. Disruption is again likely, but China and other trade partners may be more prepared and Trump’s desire to “do trades” may again limit the extent of across-the-board tariff increases.
• Being overly negative in the early stage of Trump 1.0 meant overlooking attractive entry points into the asset class. While we would caution against wishful thinking, we believe it is important to take into account the potential for upside surprises when evaluating EM markets amid prevailing negative investor investment.

A more attractive risk-return equation
The broad EM equity universe is trading at the same valuation level as 2016. Some markets, such as China, are even cheaper. By contrast, developed markets’ cyclically adjusted price-to-earnings (P/E) ratio moved 30% higher over the period, while the US market has become 60% more expensive, arguably limiting further upside for MSCI US and World indices.²

EM equities have not had a meaningful positive calendar year of inflows since 2021 and suffered near-record levels of outflows since the election according to recent EPFR data.³ Developed markets, and the US in particular, have been the beneficiary of this reallocation trade. The US now makes up almost 75% of the MSCI World Index. An underweight EM starting point is consensus across markets, which provides a solid foundation for potential flows over time.

In uncertain times it pays to remain focused on fundamentals

Visibility in EM remains low but we find growing instances of improving fundamentals, particularly in China and India, which account for almost 50% of the EM universe. 

• China: inching towards a turnaround
  China’s growth outlook remains clouded by structural challenges, including a still-challenged property market and fast-declining demographics. However, we are seeing an attempt at coordinating reforms across fiscal and monetary policies and national and local governments that target both investment and consumption. While the nature of the challenge is large, acknowledging its scale and producing a cohesive plan of action is an essential first step towards revival. We expect Chinese policymakers to cushion the downside and step in with stimulus measures should the Trump administration’s tariffs result in further weakness. The Chinese yuan, which has reached fresh lows against the USD, provides another safety valve.
  
  Policy aside, we are also encouraged by recovering fundamentals at the corporate level with renewed balance sheet strength and improving capital allocation. Chinese companies’ growing focus on shareholder returns is reflected in increased free cash-flow generation. Following a prolonged period of indiscriminate selling, the Chinese equity market is now showing signs of a potential turnaround with investors starting to reward stronger fundamentals.
• India: still opportunities despite slowdown
  We believe India is a critical component to get right in EM. In 2024, we saw Indian equities outperform meaningfully across the board, with companies with high exposure to the Indian capex cycle, such as industrials and property developers, doing particularly well. With valuations rising to a 15-year high on a P/E basis,⁴ we anticipate the market will increasingly rotate away from expensive cyclicals to high-quality compounders that are less sensitive to cycles and lagged in last year’s rally.
  
  The market will have to contend with a softer government capex cycle and signs of a slowdown in corporate earnings growth, but we still view opportunities for quality compounders outperforming despite the cyclical slowdown in India. Moreover, as was the case last time, India could potentially be a beneficiary of increased US-China frictions.
• South Korea: reasons for cautious optimism 
  In our opinion, Korea is another Asian economy that offers significant potential. While not immune to the risk of increased US tariffs, the country could also benefit from renewed investment flows as companies seek to diversify from China. South Korea was one of the worst-performing emerging equity markets globally in 2024. The surprised declaration of martial law in early December and subsequent impeachment of President Yoon introduced further policy and political uncertainty. However, valuations have now fallen to attractive levels relative to history. We are also encouraged by the bipartisan support for South Korea’s corporate “Value-up” programme, which aims to replicate Japan’s progress in enhancing shareholder value. If successful, it could help address the persistent “Korea discount”. Any signs of greater political stability or a more favourable global trade environment could provide further opportunity for multiples expansion.

Expect the unexpected
If we have learnt anything from President Trump, it is to expect the unexpected. The unexpected today is trade deals built on collaborative discussion. Aggressive negotiating tactics will be part of the new administration’s playbook; however, the economic costs of trade disruptions will be watched very closely. Having won the recent US election due to a cost-of-living crisis, pushing up inflation and slowing growth are unlikely to be tolerated for long by an uneasy electorate or a president sensitive to the mood of the nation. We believe that this unpredictability is now largely discounted. As markets broaden after an era of US exceptionalism, having an allocation to EM may turn out to be a valuable source of diversification in portfolios. After all, EM investments tend to reward the most when expectations are at their lowest, and today may just be one of those rare opportunities. 

¹Source: Analysis by Wellington Management using MSCI data from 2017 – 2020 | Data as of December 2024. | ²Source: Jefferies. Analysis by Wellington Management using data from 2017 – 2021 | Data as of December 2024. | ³Source: EFPR | Data as of December 2024. | ⁴Source: FactSet and Wellington Management | Data as of December 2024.