The Trump tantrum hits emerging markets

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The Trump tantrum hits emerging markets
The rise in the US dollar and higher Treasury bond yields mean it is rational to discount cash flows in emerging markets with a higher inflation and geopolitical risk premium.

Dubai - President-elects decisions, appointments suggests he will not gut current liberal global trading regime

By Matein Khalid

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Published: Sun 27 Nov 2016, 6:39 PM

Last updated: Tue 29 Nov 2016, 9:58 AM

The post-election macro trends in global finance have all been largely bearish for emerging markets equities, local currency debt, currencies and Eurobonds. Trump's pro-growth agenda has led to a spike in US Treasury debt, a disaster for indebted currencies dependent on offshore borrowing to finance large current account deficits - Brazil, Turkey, South Africa. The President elect threats to repeal NAFTA and the Trans-Pacific Partnership is a disaster for the Mexican peso and Southeast Asian equities.
The surge in the US dollar has pressured the Chinese yuan and even forced the Peoples Bank of China to intervene in the money markets, as the $20 billion monthly fall in its reserves suggests. In contrast, global fund managers have scrambled to buy US banks, pharma/biotech companies and industrial companies on Wall Street. As the rise in the slope of the US Treasury debt yield curve suggest, the financial markets have priced in a higher GDP growth rate and higher inflation in 2017. Donald Trump's shock win has led to a new global macroeconomic paradigm. Goldman Sachs believes this will leave the asset class "shaken but not yet stirred" in 2017.
As a survivor of the Mexican peso devaluation (1994), the Asian flu (1997), the Russian rouble default (1998), Argentina's meltdown (2001), Turkey's banking crisis (2002) and the GCC bear markets (2006-10), I am no stranger to liquidity shocks in hyper-volatile emerging markets. Global markets are linked by trillion dollar, fragile daisy chains of leverage and cross-margining. A sell off in the US Treasury bond market can mean debt carnage from Sao Paulo to Jakarta, Istanbul to Buenos Aires. Thanks to the sheer scale of global capital flows and the "herd instincts" of leveraged offshore investors, the pendulum of greed and fear swings wildly between extremes in sentiment and valuation.
Trump's post-election decisions and appointments suggests he will not gut the current liberal global trading regime.
If Trump ignites a trade war with China, Beijing could well retaliate with a major devaluation of the Chinese yuan and trigger global panic. Yet the Mexican peso's 10 per cent fall since Election Day prices in draconian restrictions on trade and immigration ("I'll build the wall to keep out the bad hombres!").
The rise in the US dollar and higher Treasury bond yields mean it is rational to discount cash flows in emerging markets with a higher inflation and geopolitical risk premium. Equity valuations in the US have gone from the sublime to the ridiculous and will fall hard if Trump cannot slash taxes, roll back regulation or spend $500 billion in shovel ready (shovels made in China LOL!) projects despite the Republican Congress.
I believe the mispricing of macro risk is now most obvious in emerging markets, where compelling value exists in currencies (Mexican peso), local debt (Indian G-Sec) and equities (Russia). Of course, these are all guesstimes since the policy agenda of the Trump White House and the Yellen Fed will only be known well into 2017. Despite his anti-Establishment rants, Donald Trump is a billionaire Manhattan property developer with an Ivy League degree, even if it is only a shlock trade school like Wharton LOL!
Geopolitics could provide its own set of shocks and black swans next year. Nikita Krusehev tested John F. Kennedy with the Cuban missile crisis, Leonid Brezhnev tested Jimmy Carter by installing KGB backed Marxist Leninist regimes in Ethiopia, Nicaragua, Angola and Afghanistan. Could Vladimir Putin test Donald Trump in Syria, Ukraine or God forbid, Poland and the Baltics?
The next big political shock to the global markets is the Italian constitutional referendum on which Prime Minister Matteo Renzi has staked his political career. If he loses the referendum, Renzi will resign. The three major Italian opposition parties - the Five Star Movement, Forza Italia and Nord Lega - are all anti-Euro and Berlin. Italy's banks face systemic risk. If Italy exits the EU, expect global markets to go ballistic.
The writer is a global equities strategist and fund manager.

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