2018: Cut exposure to EMs fast

We said:

Having reduced our exposure to EMs in April we we cut our call on overall risk to -1 (moderate negative).

Our concerns are related to the arbitrary and unpredictable environment created by multiple economic and geopolitical risks. These include the trade disputes the US has with China, the EU, Mexico and Canada, US sanctions on Russia and possible sanctions on Iran if the US pulls out of the existing nuclear agreement. Our judgment is that the likelihood of unintended consequences with negative market implications has risen significantly.

This week’s trade talks are likely to highlight not only the gulf that lies between the ultimate objectives of the two sides but also the difficulty in bridging it. Contrary to the expectations of the media and many analysts, we believe the starting point for serious negotiations between US and China is some way off and that considerable time may be needed to get there.

As a result, the risk of tit-for-tat trade actions is heightened because it is unlikely that formal negotiations will start ahead of the original deadline set for the US to make a decision on imposing tariffs, probably in late May or early June (public hearings on the tariffs end on 22 May). This deadline could be pushed back, perhaps repeatedly. Such a scenario of serial “deadlines” and rescheduling would likely be just as disruptive for markets as would be an outright trade war. In our view these risks have yet to be fully priced into markets.

 

Outcome:

Our trade war forecasts were realised. It took until August for markets to being to price in the extent of trade war escalation and the effect on asset prices. MSCI EM Index fell 11% from the date we went bearish to bottom out at 6721 on 16 December 2018. 

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