As Trump ramps up China tariffs, are emerging markets a good bet for contrarian investors?

Economic strife, currency issues and trade tariffs have pushed emerging markets out of favour. But some say that’s an opportunity for brave investors.

Professional investors are backing ‘cheap’ emerging markets after a sustained sell-off. While the US stock market has hit a string of new record highs in 2018, the impact of trade wars and economic strife has left emerging markets lagging.

The average global emerging markets equity fund is down 5.4 per cent over the past year, and global emerging markets bond funds are down an average 6.4 per cent.

China has been out of favour amid concerns about the effect of trade tariffs imposed on the country by the US. That concern is heightened by Donald Trump’s latest tranche of 10 per cent tariffs on a further $200 billion of Chinese goods.

Meanwhile, Turkey has suffered a currency crisis which recently saw its central bank raise interest rates to 24 per cent, and Argentina has been affected by a triple-whammy of high inflation, weakening currency and economic contraction.

As a result, many investors have shunned emerging markets in recent months. However, Jan Dehn, head of research at Ashmore, believes the risk of contagion to stronger emerging economies is ‘close to nil’.

He argues that countries will only fall into serious difficulties if they have been pursuing ‘misguided macroeconomic policies for a sustained period of time’ and are unable to secure domestic funding.

Dehn says: ‘The vast majority of emerging markets countries pursue credible macroeconomic policies and have strong fundamentals.’ Indeed, according to Bank of America Merrill Lynch data, EM high yield default rates are three times lower than those for equivalently rated US high yield bonds.

Edward Park, investment director at Brooks Macdonald, agrees that negative sentiment towards the region may be overdone and has been adding to his exposure to some emerging markets, although he is avoiding troubled areas such as Turkey and Argentina.

Park adds: ‘We believe the shift in sentiment has created value in emerging markets but, given the uncertain near-term dollar strength, we have only made a small additional allocation to emerging market and Asian equities and only for our higher-risk investor profiles.’

Tom Stevenson, investment director at Fidelity International, prefers China, where the stock market is more than 20 per cent lower than its January peak. He says: ‘There are certainly good reasons for this weakness, but at some point the long-term positive growth story in emerging markets will start to look compelling and, as such, the contrarian in me is starting to get interested.’

While a strong US dollar is typically bad for emerging economies – particularly those with dollar-denominated debts, which become more expensive to service – some countries, such as India, thrive in this environment as their own weaker currency makes them more competitive.

Dehn concludes: ‘The correct response to contagion fears is to look to enter the market. The deepest value opportunities often arise in the most vilified countries, because markets have proved repeatedly that they are particularly bad at pricing risks in precisely such circumstances. The smart money is therefore buying selectively in both Argentina and Turkey.’

You can see our Money Observer emerging markets fund award winners here.

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