Emerging Market ex-China Stars Strategy - Q1 2025 Commentary

Market backdrop

While technically taking place during Q2, we cannot wait another three months to comment on Donald Trump’s ‘Liberation Day’ announcements on April 2 that caused such a huge sell-off in global markets. His tariff policies are, to our mind, a bad idea but, given how much we believe was already priced into quality emerging market stocks ahead of time, the market reaction seems excessive.

Over the past decade, quality emerging market companies have shown great resilience and we strongly believe this will be another bump in the road that they will get over, once again adapting over the medium term.

As true believers in a structured world order and supply-side economics, it is hard not to be frustrated with the way Trump is conducting global policies. Before we go too far, here are some wise words of former US President Ronald Reagan explaining why free trade is good for the US and the rest of the world. He was firmly behind the principle of letting the supply-side drive the economy.

US

Globally, Q1 was about Trump’s trade policies and geopolitics, accelerating in March with the guessing game of what Trump would reveal on Liberation Day.

On April 2, Trump introduced what we are willing to call ‘peak US’. Our base case is still that Trump’s new tariff regimes are a negotiating tactic; however, we are increasingly nervous that he will not be able to manage the situation and the damage will be significant before the political balance moves to a point where it will reverse. There is also the chance that some countries are simply forgotten in the potential reversal process, resulting in large and negative consequences for many of them.

Our point is that we believe his current tariff plan will be extremely negative for the US as well – and the US has the most to lose. Hopefully, reality will eventually sink in but navigating around this outcome will be a huge task as we think the US has done irreversible damage to its global standing and the trust it has held in the past. Its ‘soft’ power – which we believe is key to the investment environment for international capital in the US – is now at risk. We think it is very likely that Trump coming into office marked the bottom of US risk premiums for equities and, over the medium to longer-term, marks a peak in the dollar (assuming there are no more military wars).

It is hard to hear Trump talk about the US being unfairly treated when we have spent most of the past decade debating US exceptionalism. It is also hard to listen to the people he has surrounded himself with given their lack of experience in these areas. As economists, it is difficult to understand the ‘academic trade-balance theory’ behind the new reciprocal tariffs. These have been imposed on US exporters as equal to ‘the value of US exports to a given country in 2024’ minus ‘the value of US imports to that same country in the same year’ divided by ‘the price elasticity of import demand’ multiplied by ‘tariff pass-through to retail prices’ then again multiplied by the ‘value of US imports to that country in 2024’.

To our knowledge, this formula is new and randomly created for the occasion. Furthermore, one of the two elasticity variables is set at 0.25 (elasticity related to import prices with respect to the tariff, even though research shows this variable in reality is closer to one); the other variable comes to four so we get 0.25 x 4 = 1.

The conclusion from the world’s biggest economy is a global tariff formula of ‘trade deficit with the US’ divided by ‘goods imported to the US’ which subsequently morphs into ‘Max (10%, (Import-Export) / Import) / 2))’.

In many ways, a fair reciprocal tariff structure could have opened up more free trade, at an equal, reciprocal rate. This could have been a positive outcome

We are not sure why the figure is 10% as it appears to be fairly random; the formula is not the same for all countries; dividing it by two is apparently so Trump could say he was being “nice”. Our frustration is that there is a real risk of these tariffs having significant implications for many countries and people. We have never seen a bigger reduction in poverty and such an improvement in people’s lives thanks to a structured global trading system. It was not perfect, but the benefits outweighed the negative costs and the US was one of the biggest winners from global trade. It is difficult to see how these policies will not jeopardize this trend for the poorest countries, many of which seem to have been hit the hardest by the tariffs.

From an emerging market and Strategy perspective, Asia was hit hard, particularly South-east Asia. For us, Vietnam was the real standout, with a tariff of 46%. So, the key consideration is whether or not the US consumer is ready to pay a great deal more for their Nike T-shirt (or any other piece of textile, as Vietnam is now a huge exporter of fashion to the US). We do not have exposure to Vietnamese exporters, but there is an indirect risk to its economy. Having said that, Vietnamese equities are extremely cheap, in our view, and we believe much of the risk was already in the market.

We obviously keep our eyes on the trade balances for the various emerging markets, and Oxford Economics has also done some excellent work on trade-weighted reciprocal tariff structures. According to them, Vietnam performed very well and, given its geopolitical importance as well as helping to reduce inflation for lower end US consumers, we thought the initial tariff for Vietnam would be significantly lower than it turned out to be.

However, at the time of writing, we hear that a senior delegation from Vietnam has contacted Trump and there are indications of him being willing to lower the tariff in return for a “phenomenal deal” – so there is a mindset for negotiation. In this regard, we have also seen Trump indicate that if there can be a deal around TikTok then he could change the tariff for China.

There are some essential tariff exceptions. Semiconductors, copper and other critical minerals, timber and special energy products are exempt. We feel that had Trump included these items, it would have been a massive own goal and quickly and significantly hurt the US.

Semiconductors is one part of our portfolio where we do have some form of direct US exposure. In many ways our portfolio is split into secular growth dynamics and strong localization. Most of our technology/semiconductor names fall under ‘secular growth dynamics’. From a country perspective, this primarily relates to Taiwan and South Korea so it looks bad given the reciprocal tariffs on both. However, adjusting for semiconductors being exempt positively changes their dynamics.

It is clear that this tariff structure has nothing at all to do with being ‘reciprocal’. In many ways, a fair reciprocal tariff structure could have opened up more free trade, at an equal, reciprocal rate. This could have been a positive outcome.

Another peculiar example is Brazil. It is well-known within emerging markets for being less than transparent and one of the countries with more restrictive trade practices – yet they were only hit with a 10% tariff.

There are many moving parts and plenty of risks. However, the bigger picture is this: the US is less than 5% of the world’s population but 25% of the world’s economy (by GDP (Gross Domestic Product)); it is an over-spender and under-saver. We do not believe it can build an economic system balancing trades with every single country. This is one of the most studied ideas in economics. Added to this, many countries have more science and engineering graduates than the US, with salaries that are – as are those for manufacturers – significantly lower than in the US. Furthermore, the US is exceptionally good in service industries where salaries are significantly higher than in the manufacturing sector. The US becoming an economy that needs to balance trade with every country will lead to significant welfare costs.

The US could keep a very asset-light model, letting other countries invest heavily in production and focus on brands and software, and then encourage its deep capital market to recycle the capital flows. This model once made the US very wealthy and powerful. Its budget deficit is an issue over the longer term, but a trade deficit can run forever – assuming the rest of the world wants to recycle capital back there. The flows occur when there is trust in the legal and political system and the returns look attractive on a risk-adjusted basis. It is this very successful model that Trump is now gaming with.

In addition, there is something very contradictory in these tariff policies – on the one hand, they are supposed to bring in “billions and billions in revenue” as other countries will have to pay “rent” to access the US market; on the other hand, they are supposed to bring jobs and manufacturing back to the US. Trump cannot have it both ways.

What are the shorter to medium-term implications of these new trade policies (assuming they stay more or less as they are now)?

We will likely see stagflation in the US as Trump’s trade policies will hit domestic growth, with a larger part of the tariffs being passed on to consumers

We will likely see stagflation in the US as Trump’s trade policies will hit domestic growth, with a larger part of the tariffs being passed on to consumers. Looking at previous experiences, it seems like everybody along the value chain will take the pain. In addition, there will likely be a volume impact so Asian exporters will be affected via volume and margins as will US importers (and they come from high valuation levels with high expectations). In the end, the consumer will most likely take the lion’s share of the pain through higher prices, though we assume most companies will try to stagger them.

This will also put the Fed under pressure. The political pressure to cut rates will be very high but inflation is not coming down.

Looking at some of the independent macroeconomic houses, such as Oxford Economics, according to their initial estimates, the US and global GDP growth will be reduced by 1.3-1.5% and US inflation could hit 4-4.5% by the end of the year. Normally, the Federal Reserve (Fed) would find it hard to cut rates, but our base case will be for some form of quantitative easing (QE) and an end to quantitative tightening (QT; we have already seen a significant reduction in bond programs).

If our readers track Truflation (Independent, economic & financial data in real time on-chain | Truflation) as well as the Atlanta Fed GDPNow model (GDPNow - Federal Reserve Bank of Atlanta), the argument for rate cuts seems to get better and better.

While we might be negative towards Trump, we are not about the American people. We all have friends in America, we have work colleagues and key American investors there and we love to travel to the US. We think Trump has been very damaging for emerging markets and think he brings huge risk to the global economy. This is about one person and a small group of people around him causing huge damage to a great number of people – and it is all so unnecessary.

Countries like India export very little to the US. There is an increasing part of emerging markets that are staying ‘local’. This is not to say there will not be a global slowdown, but many countries already have domestic drivers for their own economies.

One theory is Trump, in the short term, is nervous about the US’s debt rollover due soon, so tanking the economy will lower rates and then allow cheaper refinancing of Treasury debt.  We cannot rule this out, but it seems a bit of a stretch as this assumes Trump can control the yield curve. Using tariffs, which are inflationary, seems like an extremely risky tool to use for this end result.

We believe that in the end tariffs will be reduced from such extreme levels. However, some form of tariff will likely stay with some countries

We believe that in the end tariffs will be reduced from such extreme levels. However, some form of tariff will likely stay with some countries, most likely in our view with China and the EU as this is where Trump seems to have personal issues.

We believe there will be a mix of generating revenue from tariffs and bringing manufacturing back to the US, both at significantly lower levels than Trump originally planned for. Therefore, the US will still have a structural fiscal deficit which will keep accumulating as a longer-term risk. Some manufacturing will move to the US but it will be limited and will take time. Manufacturing is now around 10% of US GDP, down from 25% in 1970 – a consistent trend downwards. There is a lack of labor, both high-end and now low-end as Trump is chasing immigrants out of the country. Its salary base and construction costs are very high. In the end, we will see US consumers getting poorer and a duplication of supply chains.

The rest of the world will increasingly look to other parts of the world and as the US asked to be isolated, it will become more isolated. The next government will most likely try to reach out again to the rest of the world, but trust has been broken for the coming generation of international politicians.

Strategy performance

In Q1, the Strategy returned -7.8% compared to -1.7% for its benchmark, the MSCI Emerging Markets ex China Net Total Return Index (both figures in dollar terms).

Our team has been on the road a great deal since the beginning of the year, meeting with a very large number of companies and experts – virtually the complete portfolio in a relatively short space of time. Companies will be impacted in the short term by cyclical swings emanating from the US and changing global trade patterns. In general, we feel we have a portfolio with good exposure to secular growth dynamics and localization (our New Multipolar World) trends and we strongly believe this is the way to position for the coming years as ‘peak US’ unfolds, emerging markets get their investment cycle back and the super technology cycle continues to transform our world.

We believe we have demonstrated well that this strategy can create outperformance over the longer term

India had a small rally and recovered some of the significant losses over the past three or four months. However, we still marginally underperformed the broader Indian market as some of the lower quality companies had a noticeable rebound. We did see good absolute returns from some of our long-held quality Indian names.

One problem we had throughout the quarter was that a few companies contracted significantly and negatively impacted performance. Looking at the detractors, our frustration comes from them including some of our highest quality growth names that we have held for a long time and we foresee owning for many years to come.

Early in the year, Globant overegged its revenue growth guidance for full-year 2025, and since then the stock has collapsed and significantly derated. In the short term, there is a risk to the likes of Ivanhoe Mines, but we still think the world will need a great deal of copper in the next few years and there is very little new supply coming to the market – except from Ivanhoe Mines.

More broadly, looking at the stocks in our portfolio and the historical performance across our emerging market strategies after risk-off events, we feel confident we can make up the relative performance.

Outlook

We have not changed our overall longer-term outlook for emerging markets or the Strategy. However, there is no question that Liberation Day has created huge uncertainty which will impact almost every business and consumer. We think the US has the most to lose as it has been the biggest winner over the past few decades from free trade and a liberal, orderly world order. However, there will be pain along all global value chains, assuming current tariff policies stay in place.

We expect the situation to remain fluid in the short term, but we believe there is a limit to how much pain Trump can and will take. His mandate was to lower inflation – his mandate was not to burn the world to the ground and damage US international relationships, ending up with higher inflation and lower growth.

We still believe the resilience and underlying growth is hugely underappreciated for many key companies in emerging markets

Our forecast is that much of Trump’s bluff will be called as the world has been preparing for his return to the White House. We have seen big countries/regions like China and the EU willing to retaliate, with even Japan getting in on the act. We believe the whole economic model for these policies is flawed and, in our view, will ultimately backfire.

Our base case is that smaller countries such as Vietnam and Taiwan will cut deals with Trump, but countries like China, Japan and European nations will go head-to-head with him. There may be deals made but we see it likely that some form of tariff regime will stay in place, at a cost to everyone. The cost will be borne across the value chain, but we expect the lion’s share will end up with US consumers as the US cannot become a manufacturing nation overnight. We will likely end up with an expensive supply chain just for the US and US consumers will lose out, compelling the rest of the world to pursue their own trade agenda.

Given where emerging market stocks are already trading, and given a large part of emerging market quality growth names are becoming increasingly ‘local’, as per our New Multipolar World scenario, this could land well for our portfolio when the dust settles.

We still believe the resilience and underlying growth is hugely underappreciated for many key companies in emerging markets and there is a good group of ‘Star’ companies out there that we are convinced will be compounding significant economic value added (EVA) in the years to come.

From a top-down perspective, in times like this we feel it is best to stay with secular growth companies and future leaders in local business. For us, this is the recipe for good returns in emerging markets and it is how we are positioned – plus we believe our relative detractors from Q1 will make up their losses going forward.