Page 28 - Buy Russia - bne IntelliNews monthly magazine April 2017

28 I Companies & Markets bne April 2017
and in line with historical patterns, EM equity indices beat their developed market peers.
Immediately after the election this pattern broke down. While cyclicals stocks continued their steep upwards climb in abso- lute terms and relative to defensive sectors, EM stocks started to heavily underperform. (Fig.2).
A similar picture is shown if one looks at the relative perfor- mance of value stocks (unexciting but cheap stocks) relative to growth stocks (expensive stocks with expected superior earn- ings growth). Typically, the relative performance of EM stocks
“EM equities will come under pressure again and the impact could be much higher”
tends to move in line with how value stocks perform relative to growth stocks. Again this historical pattern was disrupted after the election. In contrast to EM equities, value stocks main- tained their strong momentum, on the back of growing risk appetite among investors (Fig.3).
Both the performance of cyclicals versus defensives and of value versus growth stocks suggest that EM stocks underperformed by about 15% in the six weeks after the election. Over the
same period, in advanced economies stocks rose on average by about 4%. Taking both facts into consideration – the under- performance of EM stocks plus the rally in developed markets
– implies that the Trump-fallout resulted in a 20% wealth destruction, corresponding to an absolute sum of US$1.6trn. This figure – 5% of EM's total GDP – is only slightly smaller than the combined GDP of Russia and Poland, for example.
The second reason why the immediate stock market reac- tion may not fully reflect the wealth impact of a protectionist turn of US trade policy is uncertainty over whether President Trump will ultimately deliver. While many investors – in line with the slogan of Trump supporters that the president needs to be taken "seriously, but not literally" – fear that Trump will deliver on the core themes of his campaign, others are still having doubts that the new administration will be able to significantly alter the country's free trade bias. Therefore, the actual stock price reaction after the election was the weighted outcome of those expecting a protectionist back- lash and those who are more optimistic. In case the former prove to be right, EM equities will come under pressure again and the impact could be much higher than the US$1.6trn mentioned above.
Finally, it needs to be noted that the listed corporate sector only represents a part of the EM (or any other) economies; non-listed companies will also be affected by a less favourable trade backdrop. Thus the fallout from a negative shock to globalisation is not fully captured by its impact on stock prices.
However, despite all the risks related to growing protection- ism, 2017 has been rewarding for EM equity investors, so
far. Year-to-date (to March 17), the MSCI Emerging Markets Index gained 8% in local currencies and almost 12% in US dollar terms. A number of developments that have worked
in favour of emerging markets since early 2016 helped to overcome the negative election shock: global growth has rebounded; the gap between annual economic growth in
the developing world and advanced countries is widening again; commodities have staged a recovery; and fears of a global deflation, which weighed on markets at the beginning of 2016, have evaporated. That said, these cyclical tailwinds may be tested again if President Trump get serious with his protectionist agenda.
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Fig.2: EM/DM stocks vs. Cyclical/Defensive stocks
Fig.3: EM/DM stocks vs. Value/Growth stocks