By Geoff Spiteri, BNY Mellon Investment Management
People living in the world’s emerging markets have enjoyed the fruits of tremendous growth over the past three decades. Here, Douglas Reed, Newton’s emerging market strategist, asks whether populist trade policies could derail that success.
Part 1: The elephant in the room
Consider the chart below. Popularly known as the globalisation elephant thanks to its shape, it describes how, between 1988 and 2008 the real incomes of both the world’s richest and the world’s poorest people soared. By way of contrast, the world’s middle income population, particularly lower earners in countries such as the USA and UK, saw their wealth decline over that period. Since then, the global financial crisis and its aftermath saw real incomes for the average worker in much of the developed world stagnate. In the UK, for example, average weekly earnings are still significantly (7.8%) below their 2008 peak in inflation adjusted terms.
For Douglas Reed, Newton’s Global Emerging Markets strategist, the chart helps explain why populist political movements have taken root in developed markets in recent years. “If you’re part of that ‘squeezed middle’, globalisation is likely to have been less a force for good and more a source of anxiety over the past three decades,” he says. “No surprise, then, if people are now turning to new political voices in search of solutions.”
Part 2: The long march of progress
So much for rising EM prosperity – but how much of this progress has been made at the expense of developed markets? Here, Reed points to Figure 2 below, which encompasses two trends: first that emerging markets have significantly increased trade with each other; and second that they’ve increased their respective share of exports to developed markets over the past quarter century.
On the first point, Reed notes that higher exports to China were a significant driver of increased EM export volumes. In turn, he says, this generated prosperity for neighbouring countries and commodity exporters, particularly in the noughties, with stronger growth in these countries permeating out to others via rising trade.
On the second point, Reed highlights how a far wider range and quantity of manufactured goods are now produced in in Asia and exported around the world, whereas a larger share of these goods used to be produced in developed markets. He comments: “In this respect, we think it’s fair to say EM’s relative gain has been a relative loss for at least some of the developed market’s manufacturing sectors.”
Part 3: The shadow of war?
Given this background, what are the chances for a trade war? Certainly, in the US President Trump has made clear his desire to put America First. For Reed, though, this ignores a fundamental problem, illustrated by Figure 3. “The issue with Trump’s rhetoric is that it fails to take into account the higher domestic costs of labour and the prospect of retaliatory tariffs from other countries. Far from being a win/lose scenario for America and the rest of the world, we think a trade war would likely be a lose/lose situation, with a very real possibility of higher inflation and lower GDP growth.”
Reed also points out that the decline in manufacturing jobs in the US is due at least in part to technological change and not competition with emerging markets. “Ultimately, we note that while President Trump continues to talk tough on trade and tries to browbeat other countries into submission, it seems he’s been less willing to follow this up with actions of the same severity. The current NAFTA negotiations are a good example of this. Hence, our base case is for evolutionary changes in US policy rather than an all-out trade war.”
Part 4: Shelter from the storm
Nevertheless, says Reed, there is a small tail risk that rationality does not prevail – and that even if it seems unlikely for now, over the long term the pressure for trade protectionism will rise. If this is the case, investors might be well served by taking a nuanced approach to their EM allocations. Figure 4, which charts the exposures of different EM countries to US trade, illustrates why.
In Reed’s words: “We think it makes sense not to view emerging markets as one monolithic whole but rather to consider each country on its own merits. The point is that emerging markets are not homogeneous and this needs to be borne in mind when constructing portfolios.”
Part five: Looking forward
For the future, Reed is optimistic on the wider prospects for emerging markets even in spite of the potential for increased protectionism. He notes that global trade has seen a distinct pick up, driven by China, and supported more recently by the increasingly synchronised growth in developed markets, notably in Europe.
Nonetheless, with China’s economy starting to slow, Reed’s forecast is for a loss of momentum in global trade growth in 2018. In turn, he says, industrial commodity prices, notably iron ore, are expected to correct lower. He comments: “In line with this, our expectation is for the strong performance by miners over the past year to start to reverse in the coming quarters.”
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For Professional Clients only. Any views and opinions are those of the investment manager, unless otherwise noted. For further information visit the BNY Mellon Investment Management website. INV01030 Exp 26 Jan 2018.
 Calculated by deflating UK Average Weekly Earnings: Whole Economy, Total Pay by UK CPI index. Newton, Thomson Reuters DataStream, ONS, Q2 2017.