Julius Baer Research | Emerging markets are still in a trading and not in a trending environment. The past was about central banks and monetary policy. 2017 will be about politics. We divide 2017 into two phases. In Q1/Q2 2017 we expect emerging markets to underperform and believe that there is a buying opportunity sometime in Q2 2017.
Our first key message is that emerging markets are still in a trading and not in a trending environment. 2011 to 2015 was about market de-ratings and currency adjustments, while 2016 was about a bottoming process. 2017 will be about politics, a strengthening USD and profitability relative to developed markets. Historically, sustained positive emerging market equity returns have been dependent on the presence of four conditions: i) a positive economic growth gap of emerging markets over developed markets; ii) healthy growth within developed markets themselves; iii) the direction of the USD and iv) supply/demand in commodity markets.
Donald Trump’s election puts emerging markets on hold until his economic policies with respect to immigration, foreign policy and trade become clear at the beginning of 2017. We divide 2017 into two phases. In the first phase (Q1/Q2 2017) we expect emerging markets to underperform the MSCI AC World for two reasons. First, the Trump momentum and as a result the USD could be at its strongest level beginning of the year 2017. A strong USD is by definition negative for emerging markets. Second, the consequences of his economic agenda with respect to immigration, foreign policy and trade should become clearer and reveal positive as well as negative surprises. Best case investors become euphoric and the US equity market, USD and US bond yields overshoot on the upside. In such a scenario emerging markets will overshoot on the downside, which would signal the start of the second phase. We believe in Q2 2017 there is a breaking point to what extent the USD can strengthen and US bond yields can rise at the same time.
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