Tariff twists and turns

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 As with any investment, your capital is at risk.

Things are changing rapidly. While markets are reassessing expectations for growth, inflation and the potential for a recession in the US, there are clearly numerous implications for the Emerging Markets universe. We must remind ourselves that any trade deals could have a finite life span and be ephemeral. We therefore need to be careful of being too ‘certain’ about any particular outcome and hold our convictions lightly. Our edge has always been an ability to put things into longer-term perspective. We could be witnessing quite profound shifts in global economic and political power.

So what have we been doing? 

Our first response is to have reviewed the portfolio with a distinct focus on areas of changing vulnerability to the direct impact of tariffs, as well as to companies more broadly at risk of a US recession and consequent global slowdown. We also want to keep our eyes open to where uncertainty and volatility may throw up opportunities for companies. 

Our starting point is a portfolio where the majority of China exposure is not directly exposed to trade. Over 85% of your portfolio’s China weight is in domestically focused companies or those that are in industries exempted from tariffs, with our attention going towards the small number of holdings earning a notable portion on their revenue from exports to the US that aren’t in exempted industries.

We should also remember that China has dealt with tariff threats for a number of years. Chinese exports to the US now contribute less than 3% of Chinese GDP, while at the same time, China is now the leading trade partner of over 120 countries, including eight of the top 10 economies in the world. It also has several tools available to mitigate the tariff threat, including further government stimulus, a potential tailwind for a number of companies in the portfolio. 

In India, the IT outsourcers are a key focus for us: a large portion of their revenues are linked to US spending, often discretionary. India perhaps becomes more interesting when seen in the light of its lack of goods exports. India is typically challenged for its lack of manufacturing export base within EM, but does this become a feature of resilience in a relative sense? Does a weaker dollar and a falling oil price help support a stronger view of India’s macroeconomic outlook? 

While the first order impacts of tariffs look relatively manageable, it is the secondary implications related to the risk of recession in the US and slowing global growth that concern us more. In this environment, entrenched competitive advantages matter more than ever. It is the companies with world leading products that both sides need, and countries with key resources, who stand the best chance of successfully walking the narrowing tightrope. Companies that are operating in large home markets, leading their industries, and that have business models without trade dependencies are likely to do well. These are the kinds of companies we like in our portfolios.

Questions about the impact of US-China decoupling are wide ranging and global in nature; this is not just about two countries. American withdrawal may light the touchpaper for greater intra-emerging markets trade in an increasingly multi-polar world. And that could be very important to EM investors. As of 2024, the US dollar made up only 57.4% of global foreign exchange reserves, down from over 70% in 2000.

The other side of this coin is that countries may increasingly be asked to ‘pick sides’ politically and economically. Does the ability for countries and companies to trade freely with ’both sides’ become compromised if this escalation continues? How does that alter the valuations foreign investors will be willing to pay for Chinese equities, as geopolitical uncertainty rises?

For all that we are excited about the domestic Chinese opportunity and the quality of the companies on offer – Deepseek may have just opened the eyes of the world to the levels of innovation and development in the country – China would be a larger part of our portfolios if it weren’t for geopolitics. 

As India, Vietnam and others seek negotiations to mitigate the tariff challenges, at the time of writing China is seemingly confident enough in its economic path to escalate tensions rather than lose face by being bullied into a deal. It clearly thinks it can withstand the inevitable deflationary pressures longer than the US can survive stagflation, particularly given the challenges of an electoral cycle in the US that aren’t faced in China.

It should not be a surprise, therefore, to see that the delisting of Chinese ADRs being raised again, adding further to the complexity of the situation. We should highlight this isn’t a new risk and we have significantly reduced exposure here by transferring holdings to the Hong-Kong line of stock in recent years, but it does reiterate concerns that politics may dominate economic fundamentals for periods of time. 

While uncertainty may be challenging in the short term, we shouldn’t be frightened of it. Periods of market dislocation throw up opportunities for stock pickers. A recent trip to Vietnam highlighted major economic and political shifts towards growth being supported by a focus on private sector and government reforms. Leading electronics retailer Mobile World is in portfolios, and we now have a longer list of interesting names that we may get a chance to pick up cheaper as a result of the tariff twists and turns. 

Our key message is that we’re not making any knee jerk reactions in response to the situation. We’re sticking to our long-term growth philosophy and process which has worked over three decades of investing in EM. We are thinking about what the world may look like in years to come, and how that impacts the holdings in portfolios today. It may also throw up opportunities to invest in areas that we think are exciting over our investment horizons. Patience and perspective are important.

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