Three things we are thinking about today
January 20 inauguration: America will swear in Donald Trump as its 47th president on January 20. Emerging market investors will be watching closely for details on his day-one priorities: trade and immigration. It is likely he will target China with punitive tariffs. Other emerging markets, including Mexico, South Korea and Taiwan, could also feel the impact of higher tariffs. However, US imports from these markets do not have readily available substitutes (high-volume auto parts and semiconductors), potentially reducing the risk to these economies and markets.
China’s response: Our China portfolio manager believes the more aggressive the US tariff hikes, the bigger the stimulus response will be from Chinese policymakers. We acknowledge that deflation and weak consumer confidence pose challenges to stimulating Chinese growth. Nevertheless, we remain optimistic that a proactive Chinese response to more assertive US policies will limit the negative impact on Chinese corporate earnings.
Ukraine: President-elect Trump has spoken of swiftly resolving the Russia-Ukraine war after his inauguration. Investors will focus on the likelihood of a peace deal incorporating an easing of US and European sanctions on Russia, among other concessions. A resumption of transit gas shipments via Ukraine to Central and Eastern European countries is also a focus area, given that Ukraine cut these flows on January 1. Gas storage in Europe was elevated entering the Northern Hemisphere Winter, which reduces the risk of an energy price spike in the short term. Nevertheless, significantly higher energy prices in Europe relative to the United States remain a competitive disadvantage for the region.
Outlook
Equity markets in 2025 are likely to be dealing with the after-effects of last year’s election outcomes and subsequent political shifts. Of note for emerging markets in the year ahead are the risks of higher US tariffs and policy-driven volatility as the second Trump administration enters office.
China is attempting to minimize the risks inherent within geopolitical tensions by keeping up with its policy support. In 2025, we may see signs of macro stabilization from these policies, possibly allowing scope for a cyclical recovery. Our China portfolio manager, however, feels that there may be some potential disappointment until the release of key details of upcoming policies, which will likely happen in March 2025. However, he notes that stimulus has shifted from targeting supply to boosting demand.
Taiwan and South Korea are trade-oriented countries, and therefore also vulnerable to changes in tariffs and regulations. That said, key technology-related exports of these two countries either have limited substitutes or lack substitutes, and these countries would likely be able to offset the burden of increased tariffs with their customers. We think that this reliance on exports could insulate some repercussions of domestic uncertainties. In our view, it would be challenging to implement tariffs on key strategic allies and trading partners such as Taiwan and South Korea. Our Asia equity portfolio has highlighted that the US government and political system have guardrails to prevent significant policy deviation. However, we maintain a watchful eye on developments on this front.
The Indian economy and stock market are less coupled with the United States relative to other EMs. Due to concerns of an economic slowdown and high valuations, we do not rule out the possibility that India’s equity market will correct. However, our engagement with corporations in India makes us optimistic, as companies are reporting slightly better business starting from October 2024, with most companies emphasizing that there is no further slide in growth. We see some stabilization here. We also note the Franklin Templeton semi-annual survey of our fund managers globally singled out India as a market they favor in 2025.
In Brazil, despite the country’s current macroeconomic and political landscape, digitalization is rapidly underway, spanning across sectors such as financials and industrials. This trend should help drive productivity and competitiveness and provide a foundation for longer-term growth. The higher interest-rate landscape in Brazil is another anchor for banking companies’ growth. The outlook for Mexican exports to the United States has become uncertain due to the risk of tariffs. The inflation environment in the country, while not demonstrating a clear path, has shown on and off signs of moderating. We are of the view that Mexico’s central bank has plenty of room to reduce its benchmark interest rate. Our Latin America portfolio managers believe this flexibility is likely to provide a positive backdrop for domestic demand and reduce the impact of any possible tariffs emanating from the United States.
The low visibility and high volatility in the external environment can lead to a wide range of outcomes. Given this backdrop, we continue to retain a focus on bottom-up stock selection. We favor companies with durable competitive advantages, and we look out for management teams that demonstrate flexibility in adapting to change. We believe these stocks may be able to weather this uncertain outlook and provide some form of stability for the portfolio.
Market review: fourth quarter 2024
EM equities fell over the final quarter of 2024. While the US Federal Reserve (Fed) reduced interest rates once again in December, it gave more measured guidance around additional rate cuts. For the quarter, the MSCI EM Index returned -7.84%, while the MSCI World Index declined by 0.07%.
Equities in the emerging Asia region fell. The latest activity data in China indicated that the impact of past stimulus measures has been patchy. While authorities in China pledged to increase monetary and fiscal easing, further details were scant. This caused investor sentiment in Chinese equities to dip. Our China portfolio manager believes that there was nothing surprising regarding the announcement; the release of key numbers normally happens in March.
In India, the release of disappointing gross domestic product (GDP) data for the latest quarter led the Reserve Bank of India (RBI) to lower its full-year GDP growth forecast. The RBI followed up by keeping its key interest rate unchanged and reduced the cash reserve ratio for banks to ease monetary conditions, in effect trying to shore up economic growth. Investor confidence in South Korean equities eroded over domestic political uncertainties, where the country’s National Assembly impeached both the president and then also the interim president. Taiwanese equities advanced, led by gains in chip stocks as they benefited from a technology rally in the United States.
Markets in the emerging Europe, Middle East and Africa region closed lower. Market sentiment was subdued over concerns of fewer rate cuts by the Fed in 2025. However, equities in the United Arab Emirates (UAE) performed well and rose amid the publication of preliminary economic data that said the UAE’s GDP grew by 3.6% during the first half of this year. South Africa’s economic output fell 0.3% in seasonally adjusted, quarter-on-quarter terms for the third quarter of 2024, and its inflation rate rose less than expected in November. Conversely, Turkish inflation for November was higher than expected.
Equities in the emerging Latin America region declined. Inflation environments were mixed. Annual inflation in Brazil and Peru increased in November; Mexico and Chile experienced a downtrend for the same period. In Brazil, equity prices declined following the Brazilian government’s proposal to cut US$12 billion in spending—which underwhelmed investors given the country’s challenging fiscal outlook—together with the Brazilian central bank’s higher-for-longer interest-rate policy stance. Mexico’s government announced a minimum wage hike to aid its poorest workers, which will commence in 2025.
Index Definitions
- The MSCI Emerging Markets Index is a free float-adjusted, market capitalization-weighted index designed to measure the equity market performance of global emerging markets. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges.
- The MSCI All Country World Index is a free float-adjusted, market capitalization-weighted index designed to measure the equity market performance of global developed and emerging markets. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges.
- The MSCI EM Latin America Index captures large- and mid-cap representation across five emerging markets (EM) countries in Latin America. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges.
- The MSCI Emerging Markets EMEA Index captures large- and mid-cap representation across 11 emerging markets (EM) countries in Europe, the Middle East and Africa (EMEA). Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges.
- The MSCI EM Asia ex Japan Index captures large- and mid-cap representation across two of three developed markets (DM) countries (excluding Japan) and eight emerging markets (EM) countries. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges.
- The MSCI China Index captures large- and mid-cap representation across China A shares, H shares, B shares, Red chips, P chips and foreign listings (e.g., ADRs). Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges.
- The MSCI Emerging Markets ex-China Index captures large- and mid-cap representation across 23 of the 24 Emerging Markets (EM) countries* excluding China. With 672 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges.
- The MSCI Mexico Index is designed to measure the performance of the large and mid cap segments of the Mexican market.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal.
Equity securities are subject to price fluctuation and possible loss of principal.
International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets. Investments in companies in a specific country or region may experience greater volatility than those that are more broadly diversified geographically.
The government’s participation in the economy is still high and, therefore, investments in China will be subject to larger regulatory risk levels compared to many other countries.
There are special risks associated with investments in China, Hong Kong and Taiwan, including less liquidity, expropriation, confiscatory taxation, international trade tensions, nationalization, and exchange control regulations and rapid inflation, all of which can negatively impact the fund. Investments in Taiwan could be adversely affected by its political and economic relationship with China.