Emerging markets sell-off not all down to protectionism
Protectionism theory doesn't fit as countries that had nothing to do with the TPP were hit the hardest
While most financial media attention has been focused on US equity markets’ response since the election of Donald Trump, the decline in value of emerging markets (EM) has been even more dramatic than the increase in value of US equities.
It seems like the favorite narrative of the press regarding the EM sell-off has been the “Trump is a protectionist” one. Certainly the sell-off of Mexico is consistent with the protectionism theme. Trump allegedly will tear up NAFTA, and Mexico will be unable to export to the US, and that’s why Mexico sold off.
Even the generally steady and sober analysts at Blackrock immediately after the election (within hours) sent out an update in which they zeroed emerging markets out of their model portfolio allocations – citing protectionist themes in the Trump campaign.
But does the protectionism hypothesis really fit all the evidence? For example: Canada is also a member of NAFTA and Canada not only outperformed Mexico, and outperformed EM in general, but it even outperformed DM ex US.
If NAFTA is doomed and investors know that fact and act accordingly, why did they sell Mexico, but buy Canada? One could argue that Canada is a resource producer and that commodities have generally been up since the election, but Mexico is also a commodity producer so being a commodity exporter is not a differentiator between the two countries.
Another problem with the protectionism view is that NAFTA is not the only trade agreement on the chopping block. Arguably, Trump focused more on trade with Asia during the campaign.
He relentlessly attacked Secretary Hillary Clinton for her prior support of the Trans-Pacific Partnership (TPP) deal. He often alleged that China had been engaging in currency manipulation and threatened to bring some sort of sanctions against it. The Blackrock communique specifically cited anti-China protectionism from Trump as one of the main reasons for zeroing out its EM weighting.
But there are serious problems with this view: China was an overperformer compared to the rest of the EM in the fortnight after the election. Blackrock’s opinion is that EM Asia is prior to China in the supply chain.
It just doesn’t make sense to believe that the EM sell-off in Asia was due to fears of sanctions against China
Emerging Asia builds components and sells them to China. China combines those components and sells then to the US and Europe. The protectionism hypothesis would then hold that if the US severely contracts imports of finished goods from China, China will have to severely contract its imports of components from emerging Asia.
All that might possibly be true, but if markets believed it, they would sell China too, and just as dramatically as they were selling the rest of EM. It’s hard to imagine a scenario in which China’s suppliers would be hurt due to US sanctions against China, but China herself would not be.
So it just doesn’t make sense to believe that the EM sell-off in Asia was due to fears of sanctions against China. Furthermore, another point against the China trade sanctions theory is that the EM sell-off was worse in Latin America than it was in Asia, by far.
But let’s give the protectionism hypothesis full benefit of the doubt: perhaps markets were not responding to the probability of China sanctions, but instead to the improbability of TPP.
We might be tempted to blithely dismiss this notion by saying that both candidates were against TPP, so the election of Trump did not lower the probability of the US pulling out of it.
However, let’s give the theory which we are about to refute the extra benefit of the doubt. It may not be true that both candidates were truly against the TPP. I participate in something called The Good Judgment Project, which is a tournament of experienced global event forecasters. Before the election the assigned probability of the TPP being implemented, as calculated by the GJP experts, was 50%. After the election it plunged to 0%.
GJP panelists perhaps looked at the Wikileaks revelations that Secretary Clinton had told an audience of Goldman Sachs VIPs that it was important to have distinct public and private position on issues, specifically trade.
President Obama may have had the same idea in mind when he decided not to drop the TPP effort until after the Trump election. So the TPP hypothesis is at least plausible. But does it fit the data? No it does not.
We created a database of countries which were signatories to the TPP and compared the market performance of the signatories to the market performance of the non-signatories. The results are below:
As you see, the signatories out-performed the non-signatories by a significant margin. In other words, the countries which had already signed on to TPP, and therefore had the most to gain from it, should have been the countries which were hardest hit as its prospects fizzled. But instead the countries which had nothing to do with the prospective trade deal were hit the hardest.
This is inconsistent with the theory that the EM sell-off is primarily driven by the sudden collapse of TPP probability. TPP may be a secondary or tertiary element (which would explain the differential between China and the rest of EM Asia) but it can’t be the major factor.
We’ve examined the rescinding of NAFTA explanation, the China sanctions explanation, and the pulling out of the TPP explanation, and found that the first two do not fit the data and that the last one would be at best a tangential explanation.