Given the extent of its trade with the US, investors are worried about the fallout for Asia and emerging market (EM) returns.
Historically, these markets have been more vulnerable to external shocks, especially exports. The US's push to repatriate manufacturing could also result in EM job losses.
Time to throw in the towel? We think not. The outlook for EM remains positive – here’s why.
The dollar is weakening, exposing vulnerabilities in the US financial system
Following Trump’s tariff announcement, US equities, bonds, and the dollar fell simultaneously – a scenario more common in EM than in a powerhouse like the US. Whether this stems from the US’s dependence on foreign capital to fund its twin deficits or the policymaking excesses of this administration and others is unclear.
The important consequence is the US can’t fight on all fronts and is now focusing in on China. Indeed, the Trump administration is actively pushing other nations to decouple from China.
A reorganization of supply chains will not result in an overnight switch to US production
Reorganizing supply chains will be a long and messy process. That said, this increased complexity could benefit nations focused on production. Asia and EM hold a significant comparative advantage in goods production. This dominance won’t disappear overnight, if at all (Chart 1).
Chart 1. Emerging markets shine during investment cycles
Moreover, decoupling from China means rerouting goods through other countries. The US may have leverage in some areas, like Mexico, but has less control elsewhere. For example, without massive reciprocal tariffs, how can the US realistically prevent a Chinese-owned factory in Vietnam from exporting? It’s a logistical and bureaucratic nightmare.
The US manufacturing base also faces serious challenges. These include high labor costs, a shortage of skilled workers, and infrastructure deficits. Remedying these issues requires significant capital expenditure (Chart 2).
Chart 2. Historically, as CapEx has struggled, emerging markets have lagged on declining earnings per share
It also ensures that the bulk of manufacturing will remain in various EMs.
Amid challenges, it’s not game over for China
The country has significant leverage
China has a dominant industrial base, leading in renewables, rare earths refining, electric vehicles, a competitive tech ecosystem, and a vast domestic market. Critically, it has the capacity and willingness for substantial foreign direct investment. For example, it seems highly likely that many Americans will have to celebrate this Fourth of July holiday without fireworks, as the shelves at Walmart and Target may just be empty.
China’s Premier Xi Jinping’s recent visits to Vietnam and Malaysia underscore his country’s formidable leverage in the Association of Southeast Asian Nations and its ability to foster global trading relations.
Domestically, China is ramping up policy support through trade programs, equity market initiatives, and property market loosening. With $10 trillion in consumer bank deposits, China can mobilize its elevated savings rates. The economy can also absorb some of the adverse effects of tariffs, with Aberdeen Global Macro Research having estimated 4.2% GDP growth this year.
Final thoughts
Initial reactions to Trump’s tariffs have been a mixture of shock and concern. However, beyond the first downside surprises, the long-term picture is more encouraging. Reorganizing supply chains will require significant capital expenditure, much of which will still flow to Asia and EM. US capital markets appear to be the preferred funding source. This process will take years and require substantial US investment to improve its manufacturing competitiveness. Success is far from certain. China is a formidable economic power and has been preparing for this scenario for the last seven years. Finally, with the world’s two major economic powers decoupling, we believe EMs are well placed to benefit, as recipients of incremental investment spending.
Important information
Companies mentioned for illustrative purposes only and should not be taken as a recommendation to buy or sell any security.
Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially.
Foreign securities are more volatile, harder to price and less liquid than U.S. securities. They are subject to different accounting and regulatory standards, and political and economic risks. These risks are enhanced in emerging markets countries.
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