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The author is responsible for cross-asset strategy for emerging markets at UBS.
American exceptionalism dominates the market, with the stock market outperforming other countries by 20% in the last year alone. But one of Donald Trump’s core indicators, the trade balance, remains exceptionally weak. We expect this to be the motivation for new tariffs centered on China. However, we are seeing larger market movements not within China but in other emerging countries. Here are five reasons.
First, China is exporting the strongest disinflationary impulse in at least 30 years. China’s export prices are down 18% from their post-COVID-19 peak, compared with a 5% drop globally, according to an analysis of CPB World Trade Monitor data. This de facto depreciation of the renminbi has increased export advantages to an extent never seen since the early days of WTO accession. Over the past five years, China’s exports have increased by 38%, compared to 3% worldwide. This surge in exports is mainly directed to other emerging markets.
This goes beyond simply rerouting Chinese products to the United States. It would not explain China’s export advantage over other emerging markets. Rather, this reflects the continued rise in the manufacturing value chain and the export of excess production capacity. New tariffs will further deepen the latter, impacting production and capital investment across emerging markets. While tariffs may be inflationary for the United States, the opposite will be true for these economies.
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Second, tariffs could accelerate the slowdown in imports from China that was already coming. So far, imports of primary goods have been decoupled from the slowdown in China, which is backed by strong infrastructure and manufacturing investment. New tariffs will exacerbate fiscal pressures, weaken profitability and challenge this resilience. So while China’s manufacturing competitors have so far borne the brunt of the slowdown, the next phase of growth slowdown will likely also hit commodity exporters. This cannot be compensated for by fiscal stimulus. The trend leans toward consumption, which is good for the consumer and internet companies that dominate Chinese stocks, but has little spillover to broader emerging markets.
Third, with growth currently slowing in most developing countries, the market is in a weak position to weather a potential Trade War 2.0. Outside of China, tariffs are expected to push GDP growth to 3% next year, but investment in emerging markets remains at 2008 levels as a share of GDP. Exports are also flat, and foreign direct investment has not accelerated despite hopes for “friendshoring.” Stronger support in the form of monetary policy easing is needed, but as U.S. interest rates continue to rise, the ability of emerging markets to provide support without disrupting currencies and, in some cases, credit spreads. is restricted.
Fourth, tariff-sensitive industries such as automobiles, steel, transportation infrastructure, and electrical equipment account for a higher proportion of stocks in emerging countries than in developed countries, especially outside China. This vulnerability is probably reflected in the valuations of Chinese stocks, which have not recovered from Trade War 1.0, but in other emerging markets, where valuations are 30 percent higher despite flat returns on equity. Not done.
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Finally, emerging countries other than China are also facing ever more difficulties in trade negotiations with President Trump. The composition of the US trade deficit has changed dramatically, with China now accounting for “only” 27%, while the remaining emerging markets account for 55%. Deficits with Mexico, Vietnam, Taiwan, South Korea, and Thailand are increasing particularly rapidly, increasing uncertainty.
Some investors believe such risks are already priced into valuations after recent poor performance. we disagree.
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The UBS Emerging Markets Risk Appetite Index sits about halfway between risk-neutral and risk-sensitivity, which is unusually strong compared to global growth conditions. Analysts expect emerging market earnings growth to be 14% in 2025-26, compared with the 4% realized during the trade dispute in 2018-19. The cost of purchasing insurance for even half the renminbi depreciation seen in 2018-19 is in the bottom quartile of the 10-year range. After the financial crisis, emerging market credit spreads across all rating buckets have now compressed to below the 18th percentile of their distribution.
The biggest attraction for emerging markets is high real interest rates and disinflation. This presents an opportunity for fixed income, especially currency-hedged municipal bonds. However, growth-sensitive assets, stocks and especially currencies, look vulnerable.
