The MSC Oliver container ship, operated by Mediterranean Shipping Co. (MSC), is pulled by tug boats in this aerial photograph taken above the Port of Ningbo-Zhoushan in Ningbo, China. (Photographer: Qilai Shen/Bloomberg)

A $1 Trillion Manager Expects Emerging Market Rebound on Trade Truce Next Year

(Bloomberg) -- The toll of declining business confidence will eventually make President Donald Trump cut a trade deal with China -- helping revive emerging markets in 2019, according to one of the world’s largest money managers.

While it’s unlikely that Trump and his counterpart Xi Jinping reach a truce at the Group-of-20 summit in Argentina next week, their meeting will probably be the first step toward an agreement in 2019, said Chris Gaffney, president of world markets at TIAA Bank in St. Louis. He said developing-nation assets will benefit from easing trade tensions plus a potential midyear pause by the Federal Reserve and a softer dollar. The $1 trillion investment firm manages pension accounts for higher education institutions in the U.S.

"The bleeding for emerging markets stops in 2019," Gaffney said in an interview. "Still, we don’t expect returns to continue as we’ve seen before. We think it’s lower and slower."

Developing-nation assets will likely outperform in the year ahead as geopolitical risks in Europe from Brexit to Italy weigh on the developed world, according to TIAA. Gaffney said he sees value in China’s beaten-down A-Shares market, which have fallen into bear market territory. He’s also optimistic about the yuan as well as currencies from Argentina to Brazil and India after their big selloffs this year.

Despite his optimism on China, Gaffney said a slowdown there poses the biggest risk to emerging markets. His base case is a soft landing given the amount of control in the hands of authorities in Beijing.

"China has the advantage of really controlling their economy much more directly than the U.S. or EU can," he said. "They can make it happen. They own most of the economy so they can just adjust it. That’s not always a good thing, but in trying to manage out of situations like this, it can be a positive."

Here’s what else Gaffney had to say about emerging markets:

On what markets are underestimating

"A big stock market selloff. If we go bearish global markets, that will hit EM hard. Another thing nobody is talking about is inflation because nobody expects a spike. That would help EM in that commodities would probably rally.” Still, “nobody is writing about the amount of debt out there and what happens as interest rates rise. Paying for that debt will get very expensive. It will shift spending away from other items or we’ll get some defaults."

Why he favors Brazil over Mexico

"I like Brazil going forward. There are still a lot of questions with Jair Bolsonaro. The markets like his choice for finance minister. That’s an economy with tremendous potential. Pension reform will be the big question. I’m not sure Bolsonaro and Paulo Guedes are on the same page there. Privatization is another big question. But as we see them start to get more interest from investors, I think you may see some investors shifting out of Mexico and other EMs and back into Brazil. That should give them a bit of a lift."

How Chinese markets could rebound

"I think they’ve allowed the yuan to depreciate for stimulus and to offset tariffs. In the U.S. negotiations, I think they’ll stop it. The 7 is a line in the sand and I think we don’t go through it. As the economy starts to settle in, I think you can see a nice appreciation. I’m neutral to positive on China."

On the divergence between Turkey and Argentina

"Turkey’s a mess. I don’t think investors can have confidence in their leader right now. I think it continues to be under pressure. I’m still negative."

"In Argentina, they’re taking the right direction. The peso can recover. I’m positive. Mauricio Macri took the hard step of getting the austerity budget approved. It won’t make him popular, but at the same time it makes him popular with international investors."

On his favorite emerging market

"I like India. I think it bounces up. India has very good fundamentals. Debt levels are good. GDP growth is good. India has good real interest rates, too. It’s a case of the currency. The negative push on the currency has been a case of negative EM instead of specific to India. India is probably my number one."

©2018 Bloomberg L.P.