Robert W. van Zwieten is President and CEO of EMPEA and the EMPEA Institute. In this op-ed CEO Viewpoint, van Zwieten provides his perspectives on the impact of the recent U.S. presidential election on emerging markets private capital through examining the outlook of eight "big picture" ramifications.
The election of President Trump will prove to have long-term economic ramifications that cannot be underestimated. I believe this was a tectonic shift that will pivot our world, the global economy and our industry into a new, potentially troubling direction.
There are direct lines connecting the election of President Trump with larger global trends and a sweep of troubling events in modern economic history: from the Internet bubble and economic crash at the beginning of this century to the monetary easing that followed; the Greenspan Put, the disregard of asset bubbles, regulatory laissez-faire, mispricing of risk and governance failures; to the subprime crisis that snowballed into the Global Economic Crisis, the European banking, sovereign and political crises, unprecedented quantitative easing in every major economy, negative interest rates, political gridlock on structural reforms, rising income inequality; and, all the way to the days of reckoning on the United Kingdom’s Brexit vote on June 23 and the United States’ presidential election on November 8, which can be summarized together as “the Great Backlash” punching globalization in the stomach and promising isolationism and narrow national agendas as the cure for many ills. If you still believe Brexit and the U.S. elections are isolated events, please consider that the same forces of populism and nativism, mutatis mutandis, are playing out in many other developed countries. While differences abound, the world saw a not completely dissimilar arc of history unfold bringing populism and nativism to the rise in the 1920s and 1930s, and we all know the destruction that this brought.
What does a Trump administration in the U.S. mean for emerging markets private capital investing?
One challenge in answering that question is that Trump was very light on actual policy details of any kind during his campaign, preferring to throw simple sound bites at complex problems. I believe it is hard at this stage to accurately predict what his administration will actually do, especially since reality has an awful habit of setting in when you are on the receiving end of serious responsibilities. Consequently, there very well could be a lot of light between Trump’s campaign promises and his actual policy choices – his recent and much changed comments on the so-called “Obamacare” healthcare reform are a prime example.
As a result, drawing out the implications for our industry of this electoral outcome will require some crystal ball gazing, with considerable margin for error. Following that generously sized caveat, I see the following eight ‘big picture’ ramifications for our industry, and highlight between brackets after each the outlook for emerging markets private capital over President Trump’s upcoming four-year term:
1. Emerging market allocations [mildly positive outlook]:
One thing that both Brexit and the U.S. elections make absolutely clear in the minds of institutional investors is that political risk and currency risk are not contained to emerging markets (“EM”). In the words of one CIO of a large pension fund with whom I spoke a few days ago: “Current events show us that developed markets are not as safe as we thought and emerging markets perhaps not as risky on a relative basis.” Lines have blurred and the distinction between developed and developing markets has come to matter less in terms of “riskiness.” Political risk and currency risk are everywhere, and this relative leveling of the playing field between developed and emerging markets may actually help investors think differently, and perhaps more positively, about EM allocations.
Interestingly, when EMPEA and our delegation of fund managers met with a large number of Middle Eastern institutional investors in four cities in the region back in March of this year, during our EMPEA Immersions journey there, we heard that many of them had already gone underweight on U.S. assets because they felt less welcome in the country and considered Trump a real political risk. It led these investors to start informing themselves about EM investment opportunities. I believe Middle Eastern institutional investors will increase their EM allocations in response to this election outcome. Needless to say, our next Immersions journey to the Middle East in March 2017 will be even more comprehensive: our delegation will visit six cities in the region and meet with an even greater diversity of institutional investors interested in and eager to learn more about emerging markets opportunities. This, however, may well be the only cluster of institutional investors who see reasons to divert flows into EM away from the United States.
2. EM Infrastructure [negative outlook]
While over the past seven years central bankers have used every tool in their toolbox, and monetary stimuli have run their course, governments have been either gridlocked, lacked the political will or have been engaged in generally unhelpful austerity policies, just when arguably the opposite was called for. Only now does the U.K. government seem to be intent on greater infrastructure investments and more tolerant of temporarily larger fiscal deficits. In the United States, President Obama never got very far with his proposals for a significant infrastructure investment program because the Republicans were not going to let his administration take the credit for it and thought it politically expedient to block it. Now President Trump is coming up with an ambitious infrastructure investment agenda, leveraged by private sector capital. There is no doubt that this fiscal expansion will soak up a large amount of investors’ infrastructure allocations. North American institutional capital makes up a large portion of global institutional capital and has traditionally had a home bias. Sadly, I see this will likely work out to the detriment of emerging market infrastructure allocations and, therefore, at the expense of closing the giant infrastructure supply-demand gap over the next decade that still exists in many emerging markets.
3. Inflation, monetary policy and the U.S. Dollar [negative outlook]
Trump’s fiscal activism will further strain the American employment market which is currently overall near capacity, even more so if he follows through on his threat to deport millions of undocumented workers. This will drive up inflation. The bond markets have already started anticipating this, with yields rising quickly. The Federal Reserve will likely soon raise interest rates again, and the dollar is unsurprisingly already appreciating against many other currencies.
Low yields in developed markets have inspired many institutional investors in the past few years to put money to work in emerging markets, not necessarily for the love of EM, but in the pursuit of yield. Most of these flows have found their way into EM public markets, prone to leaving again at a whim’s notice. Outflows from EM public markets have begun to take place – a “Trump Tantrum” - and the case for EM private markets won’t get any easier either as U.S. interest rates rise. The effects of higher interest rates and a stronger dollar will conspire to put considerable pressure on financial systems and currencies around emerging markets. If and when the Fed would see room to raise rates a bit quicker or more generously than we now anticipate, it might even end up destabilizing the global economy.
4. Climate change investments [mildly negative outlook]
The Trump campaign promise was to walk away from climate change treaties and commitments as well as stop all funding for climate change programs. With the U.S. being the world’s largest emitter of greenhouse gases, this dramatic reversal in the country’s policies may well reduce the resolve of some other large emitters in emerging markets to stick to their commitments and is likely to set the world onto a disastrous path toward global warming. This would be a terrible outcome that our kids and grandkids will be doomed to cope with. Investments in climate change mitigation and adaptation will be needed more than ever and will continue to make good economic sense in many emerging markets. Many subsidies and feed-in tariff schemes outside the United States will remain in place. However, higher U.S. interest rates to contain inflation will mean a stronger dollar, and thus inversely a relatively low oil price, even if the economic machine in the United States goes into higher gear. Moreover, fracking and traditional oil and gas exploration in the United States could increase as the country sets itself up for a goal of complete energy independence, as Trump promised. Fortunately, this is nothing that investors in clean and renewable energy haven’t already dealt with before while trying to make the case for investment in alternatives, and with advances in technology and declining equipment costs, this sector should remain a promising investment destination, even though the international frameworks are likely to fall apart.
5. Trade [negative outlook]
The Trump administration will no longer pursue the trade agreements with Asia-Pacific (TPP) or with Europe (TTIP) and will seek to renegotiate Nafta. Not only will we have to forego the economic gains from international trade that the new agreements would have brought to the countries involved, the risk of trade wars is real and may tip the global economy into a slowdown or recession. The Trump campaign has threatened to raise tariffs on Chinese and other imports considered unfair competition to American manufacturing. It would not take much to scare financial markets and trigger a global sell-off. Nafta renegotiations will also cast a shadow over Mexico’s trade and investment relationships with its northern neighbor and its broader economic prospects. Economic growth fueled by fiscal activism, coupled with a tighter monetary policy stance to combat inflation will support a stronger dollar, which is likely to make the calls for protectionism from businesses in the U.S. even more pronounced.
6. International political stability [negative outlook]
Not only would international stability be threatened by economic actions and trade conflicts, there are a great number of areas where a reckless and ill-tempered U.S. President, with an inclination to improvise without expert advice, but with a live Twitter feed, could provoke harmful political instability. The Middle East, the South China Sea, Iran after the scrapping of the Nuclear Accord, and even a further emboldened Russia could each create a great amount of insecurity, which will trigger immediate volatility in global financial markets. This type of uncertainty is very harmful for business in general and investing in emerging markets in particular.
7. Development policy [negative outlook]
It is unlikely that the U.S. would be able to stifle multilateral development banks’ investment policies on climate change mitigation and adaptation, but it will become an outlier in its belief that climate change is a hoax and that the fight to end poverty and climate change, inextricably linked, should not be combined. At best, the administration will leave the U.S. development agencies – USAID, OPIC, MCC – intact, albeit sans climate change-related initiatives. The base case scenario may well be that a more isolationist Trump administration breaks with the Obama philosophy that development is an effective foreign policy instrument and decides to downsize, to some degree, the remit and resourcing of its development agencies and programs, and/or fold them into other government agencies. At worst, it would seek to terminate some or all of their mandates.
8. Tax [negative outlook]
Last but not least, the favorable tax treatment of carried interest for U.S. “persons” may disappear, but the corporate tax rate is likely to be reduced to 15%. It depends on an individual’s and a firm’s tax position how this on balance may work out, but there is certainly enough advance warning on this to have been able to anticipate the possibilities here and run the numbers. A regressive tax system for individual incomes will exacerbate ballooning fiscal deficits and put upward pressure on interest rates. It would also favor the rich and further promote income inequality, setting up an ever more polarized society. Furthermore, this administration will try to get the $1-3 trillion of overseas earnings repatriated in the hope of fueling more economic growth domestically.
All things considered, I believe that the Trump presidency will pose major challenges for planet Earth, the world economy, the U.S. economy and others – including the economies of many emerging markets – in addition to global trade, international economic and political stability and consequently, emerging markets investors. My outlook overall is that the negatives seem to far outweigh the positives for our industry.
Nevertheless, the emerging markets private capital industry possesses a long-term view, is extraordinarily resourceful and resilient and knows how to adapt to headwinds, as it has shown in the past years since the onset of the Global Economic Crisis. We will need those qualities more than ever in the next four years.
Our industry is also a micro-business, not a macro-business. It does not invest in countries or regions; it invests in promising companies and projects on the ground. In that sense, it also works below the surface of political crises, newspaper headlines and erratic Tweets, so in a lot of ways it will be business as usual. Fund managers will continue to create value in companies that are providing much needed services and products, and investors will continue to seek and find alpha in these long-term private investments. This industry will continue to do what it does best, which is to navigate and tackle often complex challenges and find and execute on great investment opportunities.
Views and opinions expressed by the author(s) do not necessarily reflect the opinions, viewpoints and official policies of EMPEA and its Members.