Investors are scrambling to decide if Donald Trump’s impending return to the White House will sustain or derail the rally in emerging-market bonds witnessed under Joe Biden.
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 presidency could partly depend on how aggressive he proves to be in slapping tariffs on key economies.
If Trump carries through on his promise to impose levies on Mexican and Chinese imports then that would be “very negative” for stocks and relatively positive for bonds in Grills’s eyes. But if he’s using tariffs as a gambit to force negotiations over trade then that “would be more positive and likely support stocks to outperform dollar bonds,” he said.
EM dollar bonds outperformed stocks for the first three years of Biden’s presidency. This year they’re neck-in-neck, with the benchmark equity index returning 8.8% versus about 7.9% for bonds - though the latter came with half the volatility. Riskier high-yield sovereign bonds are up more than 15%.
What happens next could well depend on Trump.
But in a sign of what may lie ahead, dollar bonds and stocks have diverged since the start of November, with the MSCI EM equity index falling almost 4% while Bloomberg’s gauge of EM dollar debt is heading for another month of positive returns.
EM stocks started the year strong, buoyed by the expectation of Federal Reserve interest-rate cuts and stimulus measures by China. But they’ve retreated almost 10% since the beginning of October as traders started factoring in the probability of new tariffs under a Trump administration.
“A year of global unrest and economic uncertainty has led to a preference for fixed income; this has been evident with trading flows skewed towards EM bonds over equities,” said Sylvia Jablonski, the chief executive officer of Defiance ETFs. “We’ve had countries where EM bonds have offered compelling yields. Expecting US rate cuts 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 susceptible to US tariffs — accounting for 73% of the weighting. The bond gauge is a lot more diversified, with China’s weighting at just 10%.
Since Trump’s victory, Chinese equities have lost 8% and this has pulled down the broader EM index. EM bonds have had a positive return over the same time.
“The largest difference between EM bonds and EM equity is exposure to China,” said Dominic Pappalardo, chief multi-asset strategist at Morningstar Wealth. “The volatility of Chinese equity this year is the main factor that has caused performance dispersion between EM equity & bonds.”
EM dollar debt has been supported by spread compression, while the risk of default has fallen — especially in the case of high-yielding sovereigns in the wake of successful restructurings by countries including Sri Lanka, Ukraine and Zambia. But going into 2025, the risk-reward balance could change depending on the US policies and their impact on growth, said Mark Hackett, chief of investment research at Nationwide Funds Group.
“If growth is weak, rates will fall and earnings will struggle, driving relative performance of bonds over stocks,” he said. “If growth improves, however, rates will eventually rise and earnings will improve, benefiting equities over bonds.”
While US trade policy under Trump is a potential headwind, the strength of the dollar also helps Asian exporters and valuations for equities in the region are less expensive than in the US. Meanwhile, the yield premium for EM bonds over Treasuries has narrowed to more than 100 basis points below its five-year average, limiting the room for further spread compression.
For now, the strong dollar and tariff fears continue to weigh on stocks. Investors pulled $1.8 billion from EM equity funds in the week through Nov. 27, a seventh straight week of outflows, according to a Bank of America note citing EPFR Global data.
“We have favorable opinions on both EM bonds and EM equity,” said Morningstar’s Pappalardo. “Going forward, we expect the returns of the two asset classes to normalize with equities outperforming bonds on average.”
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