Webinar replay | EME: Unlocking opportunity amid uncertainty

Hi and welcome, everyone. So, before we start, I just want to give a quick reminder that this session has been approved for continuing education credit. So, for those of you looking for that, please use the QR code or the link that was provided in your email right now. And then at the end of the presentation, there will be a four-digit PIN to provide to check out as well.

So, with that out of the way, my name is Alissa Howard and I serve as a product specialist to our emerging market equities team here at RBC. I am joined here today by Phil Langham, our head of emerging market equity and our lead portfolio manager. Phil joined RBC in 2009 to establish RBC's EME platform and brings over 30 years of investment experience to the table.

So, needless to say, it's been a pretty volatile period in the markets, particularly since the beginning of this month. But with volatility often comes opportunity. So, we are here today to discuss our views on the current, but also the forthcoming, market environment. So, kicking it off and really getting right to the point, Phil. So, Phil, thank you for being here.

But my first question to you is why was there such a negative reaction to Trump's tariffs announcement? And what do you think has caused him to subsequently back down?

Yeah. Thank you, Alissa. Good morning to all of you. So I would say when we first saw Trump's announcement, really what we saw was the scale, the breadth.

But in particular, the methodology that was used in terms of determining tariffs really came as a shock to investors. The methodology was basically based on relative trade deficits. You can see the absolute trade deficits for emerging markets here, on the right-hand side. What we saw or what we've seen in terms of this sort of tariff environment that we're in is that there’s been confusion from investors, but perhaps much more significantly, there's a lot of confusion amongst corporates, who are the people who have to make the long-term investment decisions.

One of the objectives of the tariffs, supposedly, has been to support Main Street. But what we see with tariffs is they turn out to be a huge, overall tax. And perhaps more importantly, a very regressive tax.

If we turn to the next chart, what we can see from this chart is that the tariffs, if you look at the chart on the right-hand side, would have implied a smoothing from duties representing currently around 2.5% of GDP all the way up to 22%. That's a level that hasn't been seen since the 1930s.

And economists generally feel that the tariffs that were around in the 1930s had a very significant impact on causing the depression. And, of course, trade is significantly more important now. Now, if we turn to the next chart, the issue that the U.S. currently faces is its twin deficits. So, we saw in February that the trade deficit hit 4.4% of GDP.

And the fiscal deficit, in February, hit 7.3% of GDP. And that's a level where revenues are only just able to cover interest rate payments plus entitlements. Now, with the meltdown that we saw once tariffs were announced, in the U.S. dollar, in the equity market, but perhaps most, significantly, in the bond market.

And it's never a good thing to see Treasuries sell off in the face of slowing growth. We would say that it's going to be very difficult for Trump to raise tariffs again back to the sorts of levels that he was looking at on the 2nd of April. Markets are going to be very unlikely to let Trump be able to do that.

Great. Thanks, Phil. And speaking of the U.S. dollar, it's been a very important topic when we're looking at emerging markets about how the U.S. dollar has weighed and the strength of the U.S. dollar has really weighed on emerging markets. Where do you see the U.S. dollar going, and how important do you think that is for emerging markets going forward?

Phil Langham

Yeah. So, where you can see here a chart of the U.S. dollar going back to 1973. And what you can see is that the dollar tends to operate in very long cycles. And historically what we've seen is that a weaker U.S. dollar, such as what we had between 2001 and 2010, is very supportive for emerging markets.

Whereas a strong dollar, which is what we've had in the last 12 or 13 years, tends to be a real headwind. Now, what we tend to see at the peaks and troughs, is that the dollar is either very overvalued or very undervalued. So, the dollar looked very undervalued in 2011. It's looked very overvalued for, for two or three years now.

We have at last this year started to see the dollar weaken. And given the valuation of the dollar, given the large twin deficits and given that it's also very much U.S. policy to see a weaker dollar, we would say that the case for the dollar to weaken over the medium term is now a very strong one.

And I guess, speaking of shifts in various asset performances, but we've also started to see a real shift in global equity performance. So many non-U.S. markets, including some of those within emerging markets, have been outperforming so far this year. So, do you think that this is something that we can continue to see going forward?

Yeah. Again, so very similarly to the to the dollar, what we've seen historically with emerging markets relative to developed markets, is these very long cycles that you can see here.

So, going back to the 1980s, you can see that we've had two long up cycles and two long down cycles of relative emerging market performance. Now, in the fourth quarter of last year, we had lots of talk of U.S. exceptionalism, and we actually saw U.S. market cap almost hit 70% of global market cap.

That's up from 40%, 10 or 11 years ago. Since then, as you mentioned, we have seen the U.S. start to underperform. And we feel that the case for us to be in a new cycle of EM outperformance is very strong. First of all, there's that U.S. dollar link. So a weaker dollar will very much support stronger EM performance.

But there's also an incredibly strong valuation gap. Emerging markets are trading at roughly half the multiple of U.S.

Great. And with that said, and maybe so looking a little bit more near term and getting back to the topic of tariffs. While, of course we haven't settled on what any of the rates will be at this point. But how do you think emerging market countries are going to be impacted by this tariff? Is it going to be widespread or is it more country specific?

Yeah, I'd say, first of all, if we look at how individual, emerging markets are exposed to the U.S., what we can see, if you look at the chart on the left-hand side and look at the blue bars, what this shows is the percentage of GDP for exports to the U.S. represent, and what we can see is that outside of Mexico, for the vast majority of countries, exports to the U.S. represent a relatively small part of GDP.

So, we have two or three countries - so Taiwan, Thailand, Singapore, Malaysia - where exports to U.S. GDP are around 5 to 10%. But for every other emerging market you can see that it's relatively low. So for example, if we look at China, we can see that exports to the U.S. represent 2.5% of Chinese GDP.

In the case of Mexico, which is the one emerging market where exports to the U.S. are very significant, in terms of where we are currently with tariffs, Mexico's actually come out reasonably well. And looks set to gain market share, we would say, particularly from other Asian emerging markets but also from China.

Now these tariffs can change. But certainly in terms of where we are now, you know, we would say that things are relatively favorable for Mexico. And we've actually seen the Mexican stock market be one of the strongest stock markets year to date.

Right. And one of the biggest questions that we're facing, and one that we've received from some of the participants that are here today on the webinar, something that we probably talk about every single day at this point. But, we're facing the relationship challenges between the U.S. and China. How do you see the trade war between these countries playing out? What are the implications for China? You can't talk about EM without talking about China. So on any of these, that would be very helpful.

Yeah. What we've seen really since the April 2nd announcements, is that it seems relatively likely that the U.S. will move from really forging a trade war with all countries, to one that's much more centered on China and perhaps one where the U.S. looks to isolate China.

Our view would be that the U.S. is very unlikely to be able to form a global anti-China coalition. But we do think that as part of the negotiations with other countries, the U.S. will be able to try and prevent China from re-exporting or from indirectly exporting to the U.S. via other countries.

Now, one of the issues where we would say there are a lot of mixed views at the moment is whether or not China and the U.S. can end up forming some sort of a trade deal together. There has been slightly more positive news on this in the last couple of days. And China has shown some intent towards wanting to speak with the U.S.

But it's still very early in terms of really being able to determine to what extent any talks that do take place will lead to a deal. One thing, we would say that that would very much perhaps support having a deal is that it's clearly in both countries’ interest for that to happen.

Both countries are suffering significantly from an economic point of view, from the escalating trade war between the two of them that we're seeing. And, interestingly enough, most economists would say that at least in the short term, the U.S. perhaps suffers even more than China from a trade war, because China's exports to the U.S. are much more difficult to replicate in terms of new supply chains.

Now, what we've seen ever since the trade war started several years ago, is that in general, China has been able to navigate it pretty well. If you look at China's trade surplus, it's doubled in the last five years. If you look at the blue bars here on the left, which is looking at China's exports, they've actually held up very well.

And what we've seen is that China has very much been able to move up the value added curve in terms of exports, but also substitute U.S. exports for emerging markets. So, five years ago, the U.S. represented something like 20% of China's exports. Currently it's just under 15%. We can see on the right-hand chart that China has been able to substitute them by increasing into emerging market exports.

The other factor that we would expect to see from China is much more of a focus on supporting domestic demand. Consumption as a percentage of GDP in China is still very low. And interestingly enough, what we've seen from China is that at the end of last year, for the first time in many years, China has made supporting domestic demand its priority.

Right, and maybe sticking with China. We've seen a lot of headlines around the U.S./ China trade war and very specifically more around the technology sector. So earlier this year, we saw that announcement come out of China with DeepSeek. And they really revealed very advanced AI technology that really was starting to challenge this exceptionalism around U.S. tech and AI advancements in general. So what sort of implications on the ongoing U.S./China tech war do you see related to this type of announcement?

Yeah, so what we've seen basically since the tech war started in 2019, is that China has actually become a leader in a number of different areas of technology. So electric vehicles, batteries, drones, 5G, high speed rail.

And perhaps if you look at the chart on the left, it's not surprising when we can see that China produces more STEM graduates - so science, technology, engineering and math - than pretty much the rest of the world put together. And interestingly enough, if we look at the right-hand chart, what we can see is that a higher percentage of graduates in China do STEM subjects, really, than almost any other country.

So, China has put a real big focus on tech. Now, while perhaps it's not been surprising that China can end up being a leader in areas such as electric vehicles and batteries, nobody expected China to be able to compete in AI, but when the DeepSeek news came out, it really did show that perhaps the U.S.'s focus on really trying to prevent China from upgrading its tech from being leaders overall in tech hadn't worked.

Now, the question from here is, will the authorities in the U.S. double down on their focus on really trying to prevent China from being able to produce or progress from a technological point of view or will the authorities realize that essentially this has backfired and perhaps they'll look on being, or allowing, China's access to tech to be part of some sort of overall trade deal.

Right. Moving on to another country and maybe everybody's favorite emerging market these days. But can you give us some of your thoughts on India?

Yeah. So, India's a market we've always liked. India has very strong long-term macro factors that have more recently been supported by great reforms from the government.

One of the other factors that's really supporting India at the moment is a renewed CapEx cycle. The CapEx cycle really started with government support from infrastructure. And we've seen more recently that private sector CapEx has started to tick up.

So, it tends to be a great environment in which to invest. The big issue more recently in India has been valuation. And you can see, looking at the chart on the left-hand side, that valuation, towards the end of last year, got to very high levels. And if we look at the right-hand chart, there are certain parts of the market so small- and mid-caps, but also, stocks linked to the CapEx cycle, more industrial stocks, where in particular we would say that the valuations really looked very extended.

Now, we've since seen a very meaningful correction in India, You can see how, over the last six months, valuation has come down to a much more reasonable level. We still would say that it's very important within India to be selective. One of the advantages currently with India is that India tends to be a much more domestic market than other emerging markets.

It's relatively immune, or less geared to, both the China and the U.S. economies. So our feeling would be, having looked sort of very expensive several months ago, we would now start to be warming up again to India in this sort of environment.

Great, that makes sense. And maybe just sticking with country perspective. What are your current views on Latin America?

Yeah. So Latin America would actually be one of the regions where we're very positive at the moment. One of the things that's interesting about Latin America is the politics and what we've seen historically is the politics tends to move in waves.

Three or four years ago, we saw a large cycle of very left wing governments be elected throughout Latin America. And for the most part, that's been quite a big overhang in recent years. What we've seen more recently, is a number of more moderate, more central, more right wing governments be elected and we expect this trend to continue.

So we're starting to see much more positive support from a political point of view. We also see, that in Latin America, Latin America is currently very competitive, has generally come out very well in terms of tariffs. Manufacturing wages are very attractive. And you can see on the left-hand chart how valuation is particularly attractive currently in Latin America.

We also see, as you can see from the right-hand chart, is that of all regions, the region that actually benefits the most from U.S. dollar weakness is Latin America. So in our view, quite a big number of reasons to be positive on the Latin American region.

Yeah, absolutely. And maybe flipping back to the sectors and looking back at the tech sector, how do you view the tech sector overall in emerging markets?

Yeah. So what we've seen in recent years is that the tech sector in emerging markets has very much been driven by AI. We’ve seen huge CapEx in AI in recent years. You can see here the CapEx from the four big hyperscalers in the U.S., and it's really surged over the last couple of years. What we would say is the DeepSeek news that came out earlier this year, perhaps is making people start to question the sorts of returns that companies will get on this CapEx and question the pricing power of a lot of the players within AI.

Our feeling in terms of tech has been that over the last couple of years the best way to play the IT sector has really been through the picks and shovels of AI. So for us, that's very much the leading semiconductor stocks that have had very strong pricing power.

Now we feel that following the DeepSeek news, that playing AI is still going to be very important, benefiting from the growth that we're likely to see in AI is still very important, but we feel the costs within AI are likely to come down. And that perhaps moving away from playing the picks and shovels, but more moving towards playing beneficiaries of lower AI costs. So internet companies, IT services, software companies, within the IT sector, is going to be much more the way to go.

Great. And also again, kind of sticking more to the sector side. We've talked about tech now, but what sectors in general do you tend to prefer?

Yeah I'd say in general we prefer more domestic sectors that are driven by long term themes. So sectors like financials or the consumer sector, we'd say that that makes particular sense in this environment, and the more domestic sectors would be relatively shielded from what's going on in terms of tariffs.

We're also likely to see domestic support, domestic policy support, for these domestic sectors. One of the sectors that we've tended to like over the long term has been financials. One of the interesting things about financials that we see in emerging markets is that the very best financials – the best banks, the best insurance companies – are really able to maintain their competitive edge over very long periods of time.

One thing we also observe, that's interesting, is that in general, periods of U.S. dollar weakness tend to support financials, tend to support credit creation. And it's the opposite. So periods of dollar strength tend to be much more supportive for the IT sector. So generally the IT sector, and we see this in both emerging markets and developed markets, does well in periods of U.S. dollar strength, such as what we've had over the last 12 years. We would say that the case for financials to start to do much better than IT, going forward, is a very strong one.

Great. And we have had a couple of questions come in from the audience. But before we get to that, our final prepared question and again, one we've received so far, is outline the relative case for emerging markets versus developed markets and the U.S. How do you think emerging markets would perform if we actually do see a bear market in the U.S.?

Yeah, I'd say that emerging markets are clearly likely to be driven in the short term by what's going on in global markets, by what's going on in the U.S. And it'll be impossible for emerging markets to be unaffected by what's going on in the U.S. market. What we've seen over the long term, and you can see this from the chart here is, you know, we would say that it's impossible to predict how long the weakness in a market like the U.S. will last.

Getting timing right is always extremely difficult. But if we do take a longer-term view, what we can see from emerging markets is that looking at current valuation levels, we've always, on a ten year view, seen positive returns. And those returns have tended to be between about 8% and 13% a year. So I think it's important, you know, with all the volatility that is going on, to recognize that the absolute long-term case when investing in emerging markets is still a very strong one.

Absolutely. And we do have some time for some questions that have come in. So I'll start with one then I'll kind of combine it together. But it is, what is your approach to investing in state owned enterprises and in particular in China?

Yeah, I'd say for me, when investing in emerging markets in general, it's important to think about the management, owners, to really feel their interests are aligned with your own to get a sense of how entrepreneurial they are, how trustworthy they are.

And what we see often in state owned enterprises, is that state owned enterprises are not necessarily run for long-term shareholders. They are often run for the state. So it's important to be cautious. That's not the case for all state owned enterprises. But we would say, that for many state owned enterprises, and particularly those in a market like China, it is important to be very careful when investing in those companies.

Great, and then one last one as we are kind of running up on time. But what are your views on investing in Africa these days?

Yes. So, in terms of investing in Africa, what we see is that really outside of South Africa, most of the other markets in Africa are very illiquid, and often very difficult to source good long term investments.

They've also tended to be very volatile. A lot of the markets, so Nigeria, for example, tends to be very driven by the oil price. And we've seen the currencies can be quite volatile. We do feel that one good way of accessing a lot of the African markets is through South African corporates. So, a lot of South African corporates have been expanding to other African markets.

And for us to think in terms of, thinking about the best way to access Africa as a continent, now, given the liquidity that exists, we would say that perhaps investing through South Africa would be the best route.

Right. Well, thank you so much, Phil, for walking us through all that. And thank you, everyone for joining us today. We really appreciate the opportunity for us to share our views. And as always, please feel free to reach out to your RBC representative for any questions that we may not have gotten to today.

And then lastly, for those looking to receive their continuing education credit for your attendance today, please use the Attendance Tracking platform and use the PIN number you can see here: 7834. But again, thank you everyone for joining today and looking forward to connecting soon.

Thank you.