As investors navigate the uncertainty of global markets, attention has turned to the potential implications of Donald Trump’s anticipated return to the White House. His trade policies, particularly around tariffs on key economies such as China and Mexico, are poised to be a critical factor influencing emerging-market (EM) bonds and equities.
With the rally in EM bonds under President Joe Biden potentially at stake, market participants are assessing whether Trump’s policy approach will sustain or derail this momentum.
Jeff Grills, head of US cross-asset and emerging-markets debt at Aegon Asset Management, notes that Trump’s trade policy could have divergent impacts on markets. If Trump aggressively pursues tariffs on imports from economies like China and Mexico, this could negatively affect equities while benefiting bonds.
In contrast, using tariffs as a strategic bargaining tool for trade negotiations may support equity markets, allowing them to outperform EM dollar bonds.
This dynamic reflects broader market trends under Biden’s presidency. EM dollar bonds consistently outperformed equities during Biden’s first three years in office. In 2023, the performance gap narrowed, with equities delivering a 9% return compared to 8.4% for bonds.
However, bonds maintained their appeal by offering lower volatility. High-yield sovereign bonds, a riskier segment of the EM debt market, stood out with a 15% return, showcasing their ability to attract yield-seeking investors.
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Recent months have seen a notable divergence between EM stocks and bonds. Since November, the MSCI EM equity index has declined by 3.7%, while Bloomberg’s index of EM dollar debt has posted positive returns. This trend highlights how sentiment around trade policies and macroeconomic factors can drive market behavior.
The outlook for EM equities started strong in 2023, buoyed by expectations of Federal Reserve rate cuts and potential stimulus measures from China.
However, since October, equities have faced a nearly 10% pullback. Investors are factoring in the likelihood of tariffs under Trump, which could pose challenges to export-driven economies heavily weighted in the EM equity index, including China, South Korea, India, and Taiwan.
The concentration of risk in EM equities contrasts with the diversification of EM dollar bonds. While equities are dominated by a few economies—China alone accounts for a significant share of the MSCI EM equity index—bonds are less exposed, with China comprising just 10% of the bond gauge.
“Volatility in Chinese equities has been the primary driver of performance dispersion between EM equities and bonds,” notes Dominic Pappalardo, chief multi-asset strategist at Morningstar Wealth. This year, Chinese stocks have experienced significant declines, pulling down the broader EM equity index.
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Meanwhile, EM bonds have benefited from spread compression and lower default risks, particularly among high-yield sovereigns like Sri Lanka, Ukraine, and Zambia, which successfully underwent debt restructurings. The yield premium for EM bonds over US Treasuries has narrowed but remains attractive to income-focused investors.
Looking ahead to 2025, the relative performance of EM bonds and equities may hinge on the direction of US trade policy, global growth prospects, and Federal Reserve actions.
Mark Hackett, chief of investment research at Nationwide Funds Group, explains that weaker global growth could favor bonds, as falling interest rates would drive bond prices higher. Conversely, a growth rebound could boost equities, supported by rising corporate earnings.
The strong US dollar is another factor shaping EM markets. While it weighs on equities by increasing the cost of borrowing in local currencies, it also benefits Asian exporters, which could offer a silver lining for certain EM equities. Moreover, equity valuations in emerging markets remain lower compared to US stocks, providing a potential entry point for long-term investors.
Despite challenges, many experts maintain a favorable outlook for both asset classes. Sylvia Jablonski, CEO of Defiance ETFs, highlights the appeal of EM bonds, noting their compelling yields amid global economic uncertainty. Meanwhile, Morningstar’s Pappalardo believes that the returns of EM bonds and equities will normalize over time, with equities expected to outperform bonds on average.
Investor sentiment remains cautious, as evidenced by the $1.8 billion outflow from EM equity funds in the week ending November 27, marking the seventh consecutive week of withdrawals. This reflects persistent concerns over trade tensions and the broader macroeconomic landscape.
As markets prepare for potential policy shifts under a Trump administration, the interplay between trade policies, growth dynamics, and monetary actions will likely shape the trajectory of EM bonds and equities.
For now, the focus remains on balancing risks and opportunities in these volatile but potentially rewarding markets. Whether bonds continue to outperform or equities regain their footing will depend on how global and US-specific factors unfold in the coming months.
Investors would be well-served to remain diversified and vigilant, recognizing that both EM bonds and equities offer unique opportunities in the face of uncertainty.
Bloomberg