(Bloomberg) — Investors are scrambling to decide whether Donald Trump’s return to the White House will support or derail the rally in bond yields witnessed under Joe Biden.
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According to Jeff Grills, head of US cross-asset and emerging markets-debt at Aegon Asset Management, whether equities or bonds benefit most from Trump’s second term may depend on how aggressive he is in slapping taxes on key assets.
If Trump carries out his promise to impose tariffs on imports from Mexico and China it will be “bad” for stocks and soft for bonds in Grills’ eyes. But if he is using tariffs as a gambit to force negotiations on trade then “that would be good and it could support stocks to outperform dollar bonds,” he said.
EM dollar bonds outperformed stocks for the first three years of the Biden presidency. This year they are neck-and-neck, with the benchmark equity index returning 9% versus 8.4% for bonds – although the latter came with half the volatility. Riskier high-yield sovereign bonds are above 15%.
What happens next may depend on Trump.
But in a sign of what may lie ahead, dollar bonds and stocks have diverged since early November, with the MSCI EM equity index falling 3.7% while the Bloomberg gauge of EM dollar debt is heading for another month of positive returns.
EM stocks started the year strong, boosted by expectations of Federal Reserve interest-rate cuts and stimulus measures on Thursday. But they have retreated nearly 10 percent since early October as traders began to take advantage of new tariffs under the Trump administration.
“A year of violence throughout the country and economic instability made people choose their income; this has become evident with the sale of fixed flows to EM bonds over prices, “said Sylvia Jablonski, chief executive of Defiance ETFs. “We have countries where EM bonds have given satisfactory yields. The expectation of a reduction in US rates has also been a supportive factor.”
Another factor holding back stocks is that the EM equity index is heavily concentrated, with China, South Korea, India and Taiwan – among the countries most targeted by US tariffs – accounting for 73% of the weight. The bond gauge is more diversified, with China’s weighting at just 10 percent.
Since Trump’s victory, Chinese equities have lost 8% and this has dragged down the major EM index. EM bonds have had good returns over the same period.
“The biggest difference between EM bonds and EM equities is exposure to China,” said Dominic Pappalardo, senior-assets strategist at Morningstar Wealth. “Chinese equity volatility this year has been a major factor behind the spread of performance between EM equity & bonds.”
EM dollar debt has been supported by spread pressure, while default risk has fallen – particularly in the case of high-yield sovereigns following successful reforms by countries including Sri Lanka, Ukraine and Zambia. But going into 2025, the risk premium may change depending on the policies of the United States and their trends in growth, said Mark Hackett, head of investment research at Nationwide Funds Group.
“If growth is weak, prices will fall and wages will be difficult, driving bond performance over stocks,” he said. “If growth improves, however, prices will rise and earnings will improve, benefiting equities over bonds.”
While US trade policy under Trump is likely to wind up, the strength of the dollar also helps Asian traders and the value of prices in the region is less expensive than in the US. Meanwhile, the prime yield on EM bonds over Treasuries has fallen to more than 100 basis points below the five-year average, leaving room for further pressure.
For now, the dollar is strong and tax fears continue to weigh on the stakes. Investors pulled $1.8 billion from EM equity funds in the week through Nov. 27, the seventh straight week of outflows, according to a Bank of America note detailing EPFR Global data.
“We have a positive outlook on both EM bonds and EM equities,” said Morningstar’s Pappalardo. “Going forward, we expect both asset classes to return with equities outperforming bonds on average.”
For attention
China’s November Caixin manufacturing PMI reading may be the lowest since October, mainly reflecting seasonal fluctuations.
Indonesia’s inflation is expected to have moderated in November, while South Korea’s inflation data is forecast to show a rise in prices.
The Reserve Bank of India may keep it neutral at 6.50% on Friday; Price decisions are also expected in Namibia and Botswana
For Brazil, third-quarter GDP should confirm another strong quarterly increase
Countries in Latin America are expected to report mixed inflation figures in November, with figures for Chile and Colombia expected to fall; while Peru’s inflation is likely to rise
