The first few weeks of the new United States administration have made one issue quite clear: President Donald Trump is keen to deliver on his campaign promises.
One of the cornerstones of his declared policy is to negotiate better trade deals for the US with its neighbours, as well as with key trade partners in Asia.
Where does that leave trade-dependent Asia and the other emerging markets (EMs), many of which count the US among their top three trading partners? And how should investors play the emerging trend?
To tackle this question, one needs to first examine the backdrop. There are a few factors favouring EMs at the moment.
First, EM growth is accelerating relative to developed market (DM) growth for the first time since 2009, and Asia is set to remain the biggest growth driver for the global economy.
Second, EM equity market valuations are more attractive than those in DMs, after years of underperformance.
Third, many EMs, especially outside Asia, are emerging from recessions or sharp downturns in their equity, bond and currency markets.
Other factors - such as increased commodity price stability, greater reform efforts and stability in China - are also positives for many EMs. Indeed, they arguably contributed to EM equity outperforming DMs for the first time in four years last year.
Against these favourable trends, there are counterbalancing factors. Apart from the likelihood of trade frictions, the most significant risk facing Asia and EMs is rising interest rates in the US, as Mr Trump's policies could potentially generate faster growth and higher inflation. Historically, higher US rates have tended to be a challenging environment for many EMs, given the possibility of triggering capital outflows.
However, we believe capital outflows are not inevitable. There are three factors to keep in mind.
First, many EMs - including China - have already faced significant capital outflows. This suggests that the most susceptible components may already have left.
Second, the gap between the low US rates today and fairly high rates in many EMs is quite large. This may offer an additional source of support for the EMs.
Finally, US interest rates would most probably have to rise at a faster pace than what is already expected, to trigger large-scale capital outflows. Markets are arguably already looking for at least two rate hikes from the Fed this year, so an upside surprise from this baseline would likely be needed for markets to start worrying about EMs.
There could even be situations where US rates go up but are not detrimental to EM assets and currencies.
For one thing, US interest rates could rise at a much slower pace than expected. This would imply that higher-yielding EM currencies - like the rupee or the rupiah - may be less vulnerable than lower-yielding ones.
Second, EM growth could continue to accelerate relative to DM growth, which would underpin interest in EM equity exposure.
Finally, EM currencies may have already priced in a significant portion of the risks, leaving less room for further downside. The ringgit is a good example of this, given just how much it has already weakened over the past few years.
Moreover, in equity markets, EMs have a valuation advantage over DMs. On average, DMs are much more fully valued, while EMs are generally more inexpensive when compared with their respective earnings expectations. However, there is a great deal of dispersion across countries. Hence, for investors, a prudent approach would be to be highly selective.
Globally, the US and euro area are our most preferred equity markets, given their strong earnings outlook. Within Asia, Indian and Chinese equities appear most attractive, in our view, given their domestic focus, positive long-term structural growth outlook, falling interest rates and continued reform efforts.
Hong Kong and China equities have delivered solid performances year-to-date, as weakness in the US dollar helped EM equities generally. These equity markets are likely to be supported due to their reasonable valuation.
Chinese banks, with their cheap valuation and high dividend yield, should be an area of focus for local investors. Elsewhere, China "new economy" stocks are likely to do well, given their higher profit margins and better revenue and earnings growth prospects, compared with the "old economy" sectors.
Within bonds, prospects of higher Fed rates and inflation warrant a shift away from higher-grade government and corporate debt to less rate-sensitive DM high-yield corporate bonds and US floating-rate loans. In Asia, though, we believe a focus on higher-quality Asian US dollar corporate bonds is prudent, given the risks around deteriorating credit quality, especially in China.
Within currencies, the yuan is likely to continue to weaken gradually, as in past years, along with broad-based gains in the US dollar.
As Mr Trump rolls out his agenda in the first 100 days of office, it is unclear to what extent he can deliver what he promised to his constituency. A lot depends on how well he can cut deals with his fellow Republicans in Congress and how successfully he fends off increasingly strident Democrat opposition to implement tax cuts, deregulation and increased spending on US infrastructure.
For investors in EMs, the prospect for trade protectionism remains a big unknown, as many export-oriented EMs could be at risk from an increasingly protectionist world. Regardless of how these risk factors pan out, several investment opportunities exist in this politically uncertain environment.
•The writer is head of fixed income, currency and commodity strategy at Standard Chartered Private Bank.
