After five years of underperformance, the Asian markets finally seemed to have won back investors interest. 2016 was going along nicely until the American elections.

 The MSCI Asia ex Japan index was up 11% (in USD) since the start of the year, outperforming the developed markets at last. But in the aftermath of Donald Trump’s election, it plummeted while its European, Japanese and especially American counterparts rebounded (see graph). Asian markets confront the challenge of Trump or Asian markets confront the challenge of Trump or

S&P500 and MSCI Asia ex Japan in USD

Source: Bloomberg

On the face of it, there is little in Donald Trump’s programme to encourage the emerging markets: prohibitive customs tariffs having a hugely negative impact on world trade, a policy of putting America first to the detriment of economic partners and a policy to limit immigration and jobs for foreign workers on US soil. To crown it all, the dollar’s surge to a 14-year high also has a negative impact on emerging markets as many local companies have debt denominated in USD so that any hike in the dollar raises their debt burden and drives investors away.

Dollar DXY Index

Source: Bloomberg

However, if we look more closely, Trump’s election might not be quite so negative for some emerging market companies.

If customs barriers are imposed, reprisals from America’s economic partners are bound to follow, such that US companies will face similar barriers to access the leading Asian domestic markets. This will be beneficial for Asia’s leading local companies in consumer sectors. For example, a company like Hengan (present in our portfolios), the Chinese market leader for baby diapers and sanitary napkins, which only operates on the domestic market, could well see its position strengthen if protectionist measures are introduced since its main competitors include US companies Procter & Gamble and Kimberly Clark. Of course, as these two US companies manufacture their products in China using Chinese labour, they may not suffer customs duties. But, if a trade war sets in, we are likely to see nationalist sentiment rise to the fore and that could lead to a boycott of products perceived as non-Chinese.

While America is turning in on itself, Beijing has a card up its sleeve in its bid to open up the country and liberalise its economy. Trump’s intention, as stated in his campaign, to withdraw from the Trans-Pacific Partnership (TPP) is also playing into China’s hand to strengthen its dominance in the Asia region. This was underlined by Chinese President Xi Jinping in his recent speech at Davos advocating free trade. It could be very positive for Korean companies exporting to China (LG H&H, Orion, Amorepacific) which have been penalised in recent times by Beijing’s threats to restrict Korean exports to China and stall trade between the two countries following the tensions between them over the THAAD (Terminal High Altitude Area Defense) project to establish an anti-missile system on the Korean border.

Korean companies in EUR: LG Household & Healthcare, Amorepacific and Orion Corp

Source: Bloomberg

China is no longer simply the workshop of the world. Countries like Vietnam and Indonesia are taking up the challenge. Although China is still very exports-focused and could be damaged, its economic model is in the process of change. The government is trying to reduce the economy’s dependence on investment and exports and prioritise domestic consumption. The current threats from America’s new policy could well contribute to accelerating this change. Consumer-focused companies in the information technology sector, like Alibaba and Tencent, have recently shown that they are continuing to grow rapidly despite the backdrop of economic slowdown.

Exporting companies are inevitably more at risk in a context of higher customs tariffs. It is therefore more important than ever to focus on companies enjoying significant competitive advantages. For example, although companies like TSMC and Samsung Electronics are major exporters to the United States, they are not likely to be totally penalised because their customers like Apple or Qualcomm cannot simply bypass their technology in the field of semi-conductors. Maybe they will be able to create plants in the United States to manufacture the products destined for the American market. But in this case they would be forced to pass on this increase in prices to their customers who in their turn will pass it on to the end consumer.

Also, as an astute business man, Donald Trump might hope to cap the rise of the dollar which would act as a brake on the recovery of the manufacturing sector in the United States and impact the competitiveness of US companies on world markets, especially as the dollar has already gained 45% (see above graph) against its low point and is relatively overvalued in terms of purchasing power parity. Any fall in the dollar would obviously be excellent news for the emerging markets.

The fears generated by the election of Donald Trump have probably already been factored into the share prices of Asian companies. Note that they have underperformed US companies by some 90% in the last six years (see graph). In addition, in 2017, Asian companies should achieve record cash flows and are expected to post double-digit earnings growth: for example, the operating cash flow of a company like Samsung Electronics could be higher than Microsoft’s in the coming year.

S&P500 and MSCI asia ex Japan in USD

Source: Bloomberg

The companies we focus on have solid balance sheets, good growth prospects and are less cyclical than most. We tend to avoid companies that cannot demonstrate a durable competitive advantage. Consequently, our companies are relatively more expensive than the average but are also less volatile. There are times, as was the case in the second half of 2016, when the market seeks out less-expensive companies without any consideration for the sustainability of their business models. Therefore, our portfolios suffered recently in relative terms mainly due to the rise in the share prices of companies in commodities and financials sectors which are totally absent from our funds. Meanwhile, we continue to focus on consumer stocks which offer the best long-term way of capturing the growth emanating from these countries (see graph).

MSCI Asia ex Japan Consumer Staples, MSCI Asia ex Japan Discretionary a nd MSCI Asia ex Japan in USD

Source: Bloomberg

We also prefer private companies to State-owned enterprises whose debt tends to be increasing. Asian shares are not too expensive in terms of valuation and their underweighting in the portfolios of international investors looks increasingly difficult to sustain.