How trade wars have affected emerging market returns

We illustrate how trade concerns influenced emerging markets equity returns in 2018, and discuss the prospect of a rebound this
year.

The MSCI Emerging Markets Index, a measure of emerging markets (EM) equities, was down 14.3% in 2018, but this masked a considerable dispersion of returns, particularly in US dollar terms.

Turkey was the year's worst performer, thanks to a collapse in the lira, with equities losing investors 57.6% in dollar terms. The best performing major market, Brazil, was still down for the year, but only just at a less painful 0.2%. The outlier was Qatar, where the equity market rallied 29.8%, despite the ongoing economic blockade by regional countries.

The dominant common theme for emerging markets (EM) equities in 2018 was trade wars, as demonstrated by the chart below. Taking April, when the US first mooted China-specific tariffs, as a starting point, there is a striking correlation between equity performance in EM and a country's exposure to the US-China trade war, as measured by value added to China-US trade. The less exposed economies managed to eke out small positive price gains, but due to currency moves still saw a negative overall return in dollar terms.

...but are emerging markets set to rebound in 2019?

After a challenging 2018, could EM equities recover this year? Expectations for major global central banks to take further measures to tighten monetary policy, and the impact of the US-China trade dispute will not help. However, we have named the return of emerging markets as one of his themes for the year.

If our forecast is correct and the US Federal Reserve decides to end its interest rate tightening cycle in June 2019, there is a good argument to be made for the dollar to weaken. This would relieve the pressure on dollar borrowers and emerging markets. Arguably, those markets may already be discounting the worst, with both equities and foreign exchange having fallen significantly.

Macroeconomic developments will be important, and it may be that further stimulus in China is the catalyst for investors to return to the region. We believe this would help to alleviate concern over another collapse in global trade as seen in 2007-08.

Whilst US-China trade will slow, unless the trade war goes global there is no reason to expect an outright contraction in trade as activity should be diverted elsewhere.