American Exceptionalism vs. Emerging Markets

Subscribers to Chart of the Week received this commentary on Sunday, December 8.

You’re likely to hear a lot about American Exceptionalism over the next four years. U.S. President-elect Donald Trump’s administration has a well-documented transactional approach to geopolitical relations, marketed as an effort to shore up domestic coffers and rid the U.S. of outside economic reliance.

Protectionist policies could prop up a U.S. stock market that is already lapping the rest of the world. Last week, a Financial Times op-ed titled ‘The Mother of All Bubbles’ noted that the U.S. accounts for 67% of the global stock market, while the dollar sits at levels not seen since the greenback was ditched as a fixed exchange rate in 1973. U.S. stocks comprise 62.57% of the MSCI All Country World Index (ACWI) index, thanks in part to the sustained weight of growth stocks and mega caps. The success of ‘Trump trade,’ then, could have a seismic impact on emerging markets going forward.

While U.S. equities break through, developing-world equities are stuck on the sidelines. Per a Bloomberg report, “an index for developing-world equities trades near its lowest-ever level relative to the S&P 500 Index since the late 1980s.” But with valuations stateside ballooning to ridiculous levels, a contrarian investor should be watching carefully for a value-based add away from the mania in the U.S.

Assessing the viability of emerging markets depends greatly on how you see the dollar under the Trump administration impacting global currencies. After Trump won, on cue with 2016, the dollar rose in concert with the S&P 500 Index (SPX). And with a supermajority backing, Trump will more than likely get his tariffs this time around. But if tariffs and tax cuts prop up the dollar to drive home American exceptionalism, then the gap between the U.S. and the rest of the world will widen.

The first domino to fall in terms of emerging markets will be currencies. Tariffs are supposed to depreciate a target country’s currency against the dollar, essentially propping up the domestic currency. However, these tariffs have been so telegraphed by the upcoming administration that their impact on global currencies has already been baked in, and currencies across the globe have taken substantial hits already in recent months. The yen in Japan has had a well-publicized fall. The Chinese yuan has drifted lower since October. The Mexican peso has carved a channel of lower lows since July. And now the Korean won is grappling with political upheaval. Many emerging market currencies are so beaten down already that there’s not much else left to depreciate.

After Friday’s jobs data saw CME’s Fed Watch increase to an 88% chance of a rate cut at December’s meeting, the dollar cooled off some, a welcome sign to any emerging economy with stacked up dollar denominated debt that wants to see the dollar come back down to earth. With the U.S.’ Real Effective Exchange Rate hovering near 10-year highs per the CEIC, a lot has to go right for the currently overvalued dollar to benefit from Trump policies. But if tariffs and tax cuts prop up the dollar to drive home American exceptionalism, then the gap between the U.S. and the rest of the world will widen.

British investment firm Ashmore wrote this week: "Economic fundamentals improving alongside credit metrics in most countries meant we saw far more sovereign credit rating upgrades than downgrades this year. We expect this trend to continue into 2025.” In other words, there’s opportunity scattered across the globe, even if it seems every country is wrestling with domestic issues. India has narrowed China’s lead as the largest emerging market since the pandemic, and now boasts a nearly 20% weight in the MSCI Emerging Markets Index. There was a record $8.6 billion inflows last year into Indian stocks, per Reuters. Market access issues keep South Korea and Taiwan defined as ‘emerging markets’ despite their rapid advancements and status as tech incubators. Brazil’s 4.5% weight is making inroads, and a 6% dividend yield is five times the SPX’s, per the Wall Street Journal.

If you think it’s time to buy, the iShares MSCI Emerging Markets ETF (EEM) offers exposure to large- and mid-sized companies in China, South Korea, and Taiwan. One of Schaeffer’s Top 2024 picks Taiwan Semiconductor (TSM) -- the ETF’s largest holding – has powered EEM to a 9.2% year-to-date gain, with early October tailwinds from China’s latest stimulus measures resulting in a two-year high of $47.44 on Oct. 7. Since then though, EEM has shed 4.2% this quarter, and is testing its 80-day moving average.

Options tea leaves show pessimism has become more rampant. At the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX), EEM boasts a 50-day put/call volume ratio of 1.27 that sits in the 82nd percentile of its annual range. Bearish bets against emerging markets may have been a sound strategy in the immediate aftermath of Trump’s win, but going forward, it creates an already-precarious swell ready to unwind.

The Emerging Market Index gained 52.4% during the last Trump administration, but American Exceptionalism is at a premium right now, in ways that were only nascent eight years ago. With U.S. valuations skyrocketing, the question then becomes –– what do you think Trump’s policies will do to the rest of the world? In the short term, China’s stimulus plans are at the forefront of discussions at next week’s Economic Work Conference, while the Fed meeting in two weeks is another catalyst for global markets looming. In the long term, be mindful of how currencies perform compared to the dollar, and how EEM is influencing options traders.