Page 27 - Buy Russia - bne IntelliNews monthly magazine April 2017

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The trillion dollar bill of US protectionism
Peter Szopo of Erste Asset Management
Both the election of Donald Trump as the new US president and the immediate market reaction came as a surprise. Immediately after the election, US securities including the dollar soared, safe haven assets such as gold and German govern- ment bonds weakened, and risk indicators such as VIX, a widely watched volatility gauge, fell to levels last time seen in mid-2014.
Probably the only asset class that reacted as projected by market pundits before the election as emerging market (EM) securities. The JP Morgan EM bond index fell almost 6%, the EM currency index dropped 5%, and the MSCI EM equity index underperformed its developed market counterpart by 10% over the first six weeks after the election (see Fig.1).
The main reason for this massive correction was a fear that the newly elected president would deliver on the protectionist rhetoric he used throughout the campaign. Given the fact
that the business model of emerging markets to a large extent depends on exporting goods and commodities to the advanced world and opening their economies to foreign direct investments, any attack on globalisation would necessarily have a negative impact on EM growth and wealth.
It is tempting to see the correction of EM equities after the election as an indication of what a protectionist turn of US trade policy would mean for emerging economies. In dollar- terms the MSCI EM stock index lost about 7% within five trad- ing days, which translates into a wealth destruction of about US$560bn. Of course, this is a massive sum (it is larger than the GDP of Argentina or of Poland, for example), but it is less than 2% of the total GDP of emerging markets. Surely, nothing to cheer about, but also not a disaster.
Style factors
Unfortunately, there are at least three reasons to assume that the ultimate impact of the United States' adopting a protection- ist policy stance would be much more costly.
First, as in any counterfactual event study, the observable response – in this case the drop in stock prices – tells only part
Many investors follow the slogan of Trump supporters that the president needs to be taken "seriously, but not literally".
of the story. The other, often more significant part, is how the world would have evolved without the event. The question, therefore, is: how would EM stock indices have performed without a new US president pursuing a protectionist agenda?
One clue comes from the performance of what the investment community calls "style factors", which normally are highly cor- related with EM stock returns. When economic growth starts accelerating and the outlook generally brightens – as we saw in 2016 – cyclical stocks tend to outperform their defensive
“Investors fear that Trump will deliver on the core themes of his campaign”
peers. Typically, during such market periods also EM equities tend to strengthen relative to their developed market peers. And in fact, this is exactly what happened in 2016. Starting in the first quarter, cyclicals strongly outperformed defensives,
Fig.1: EM equities, FX: Post-US-election performance
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