Emerging Market Assets Will Rally On Trump’s Fiscal Policy Failure, Says Ashmore

We should not expect any major pivotal announcements. It’s more likely that they will be using as a forum for discussing the internal uncertainties about the outlook. It’s a big debate right now about whether we will continue to have soft inflation and if not whether we should go for rate hikes or balance sheet reduction. Question marks still hang over these issues.

As we approach full employment, there are two concerns for central bankers. One is inflation, which does not appear to be a major problem right now. That suggests to me that interest rate hikes become less likely than what is currently priced into the market. On the inflation side, that’s the main implication. On the other side, we have pumped in an enormous amount of liquidity into financial markets and asset prices are extremely elevated.

Trump’s performance has been dismal. The market bought into the idea that he wanted to make material changes to the U.S. economy with lots of structural reforms, taking into account that he controls both Houses of Congress. But he has not been able to deliver anything. Particularly, he has not been able to deliver the border adjustment tax and repeal Obamacare which means there is very little room for fiscal stimulus. That suggests to me that we will have very soft growth and very few rate hikes. In that environment with relatively soft U.S. growth and few rate hikes, I think the dollar looks expensive. The main implication is that the dollar will continue to decline which is generally positive for the emerging markets.

The very near-term fluctuations in flows should not give rise to too much concern. It’s important to remember that we are still in the holiday season in the Western financial markets and small events can have big repercussions in some market price action. There are a lot of major institutions which are not putting money to work. They’re sitting on the sidelines. The short-term volatility is not a source of great concern. Indian equities look a bit expensive relative to Indian fixed income. The currency backdrop for India is okay. Bonds do look more attractive than equities right now and that may explain why with that volatility you are seeing greater interest in the bond side over the equity side. India still has very significant barriers to entry for foreign investors into the fixed income markets. But such barriers do not exist in equities. To the extent that investors want fixed income more than equities, you should expect that overall flows into the area declines because India’s government itself limits how much we can invest in Indian bonds.

We certainly would and not only us. India, given the very large size of its domestic bond market, in fact, it is the second largest bond market among the emerging markets, would immediately be given a weight of at least 10 percent in the main bond market indices and all investors in the world who are benchmark investors would at least, on average, adopt a 10 percent weight for India and, I imagine, many others would have been overweight. You should expect to see a very large amount of money flowing into India. That will strengthen the currency and that will put downward pressure on inflation and enable the RBI to cut interest rates which will help stimulate Indian growth. It will be good for the Indian economy. One of the big questions many foreign investors are asking for many years is what exactly are the special interest groups that are preventing India from making this obvious and logical step.

We are more in the longer tenure and our view is RBI is not going to be cutting very much if at all. The primary reason for this view is we have seen a deterioration in fiscal policy in India recently. That is always a red flag and it should be a red flag for the RBI. If you go back not so far into the past, we have seen that, traditionally, loosening fiscal policy and excessive reliance on fiscal stimulus has been the root of all evil for investors.

That would have been my base case. But we had a recent local election in India which went very much in favour of the government which suggests that the government has more political capital that perhaps people were expecting just a few months ago. That suggests there is a small possibility that further reforms could take place.

We are being a little more cautious in the equities portfolio. We do think that the valuations are very high in absolute terms but also relative to valuations you get in other markets. We are becoming more selective, focusing more on genuine value propositions and scaling back a little bit of our exposure in the cyclical stocks.

It is very important to be very selective in Indian banks. There is considerable weakness in a number of Indian banks. But there are others that offer good value and you need to be quite selective where you go in. The fact that credit growth is relatively low is ultimately a good starting point. There is room for some banks to increase their market share and to broaden their activities in financing the private sector. But the banking sector as a whole, is still being held back by the vulnerabilities of parts of the public sector banking system.