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How a Trump win could put emerging markets in a tailspin

Donald Trump at a campaign rally in Delaware, Ohio, on Oct. 20, 2016
Jonathan Ernst | Reuters
Donald Trump at a campaign rally in Delaware, Ohio, on Oct. 20, 2016

With only a day until Election Day, it's safe to assume that investors around the world are anxiously waiting to see who will come out on top. European markets rallied Monday after the FBI announced Sunday it was dropping the investigation into the Democratic candidate Hillary Clinton's use of a private email server following a review of newly discovered emails from an unrelated investigation of Anthony Weiner, the estranged husband of top Clinton aide Huma Abedin.

But while many people are talking about how U.S. markets might react — many say a Donald Trump win would cause more volatility — there are a number of other countries that could see their own markets fluctuate after the polls close, especially ones in emerging markets.

So far this year, developing-nation stocks are up the most they've been in seven years. Year-to-date, the MSCI Emerging Markets Index has risen by nearly 13 percent, with some countries, such as a Brazil, Russia and Peru, up well over 70 percent. As good as a run as it has been, though, some people are worried that the election, and in particular a Trump win, will derail these gains.

In September, Citigroup released a report saying that the MSCI Emerging Market Index would fall by about 10 percent if Trump wins, in part because emerging market currencies would weaken against the U.S. dollar. The main concern is that any tough action on trade — he says he wants to renegotiate NAFTA and scrap the TPP — would harm developing nations that sell their goods in America.

"In a worst-case scenario, if the U.S. is less driven to trade globally, and where immigration becomes more of an issue, then clearly emerging markets would suffer," said Julio Zamora, a managing director at Citigroup.

Not surprisingly, Mexico is one country that could be impacted greatly by a Trump win. Altering NAFTA would certainly hurt a number of sectors in Mexico, such as its growing auto industry, which is expected to see a 56 percent increase in vehicle production between 2015 and 2020, while the Mexican Bolsa, its stock exchange, would likely take a hit as well. Last March, Richard Schmidt, co-manager of the $2.4 billion Harding Loevner Emerging Markets (HLEMX) stock fund, told Reuters that a Trump victory would "absolutely destroy" Mexican share prices.

The impact on Mexico

A Trump win would impact the Mexican peso as well, and its currency does seem to be correlated with the Republican candidate's prospects of victory. In September, when polls appeared to be tightening, the country's currency fell by 5.4 percent against the U.S. dollar. However, since the first debate, on Sept. 26, the peso has climbed by nearly 4 percent, indicating that Trump's chances of winning have declined.

"As the probabilities have become more one-sided, the correlation of the peso has been increasing," said Zamora, adding that earlier on in the year, investors had hedges on the peso, which are now starting to come off. "It's probably going to go to one extreme as those positions wind down." In its report, Citigroup predicts that a Trump win would cause the peso to fall by about 7.5 percent from where it is today.

A falling currency could actually help Mexico's manufacturing sector — it would make exports to the U.S. cheaper — but additional tariffs on the country's goods, and tariffs on other nations, would outweigh any positives to a weaker currency.

Tipping point for China

China could also be impacted negatively during a Trump presidency. In an interview with Pensions and Investments, Gary Greenberg, head of emerging markets at Hermes Investment Management, said that Trump "could easily impose 30 percent to 40 percent tariffs on China agreements, for example — there are arguments to which (country) would be the bigger loser, but it would certainly be a disaster."

In a note to investors, Kevin Lai, the Hong Kong-based chief economist for Asia at Daiwa Capital Markets, said that a 45 percent tariff on Chinese goods, which Trump has suggested implementing, would result in an 87 percent decline in Chinese exports to the United States. That would reduce China's GDP by 4.82 percent over time, he said.

"A loss of GDP or a slowdown in GDP growth of this scale would be staggering," wrote Lai wrote in his note.

As such, investors shouldn't do anything drastic to their portfolios, said Michael Thompson, managing director and chairman of S&P Investment Advisory Services, which has several billion dollars invested in emerging market countries. At the moment, there's a lot of talk, but there's not enough information to know what will actually happen if Trump — or Clinton, who says she wants to alter the TPP agreement — wins.

It’s a waiting game

"The market just doesn't have the kind of information it needs to make any determinations as to what would change," Thompson said. "These changes are complex, and it's not like anyone can turn a light switch on and off."

First of all, Trump would have to win for emerging markets to get spooked, and he's still trailing in the polls. Secondly, Congress would have to agree to open up past trade deals, and then engage in a long process of renegotiation, and it's not yet known if it would do that.

Investors understand that it's a long process, says Thompson. "There's a legislative component to this, so you could want something really badly and be stymied," he says.

Still, he will be watching to see how a new president and new Congress approach trade and immigration. If the possibility of material changes to America's trade deals increases, and if these changes can actually get through the house and senate, then he'd rethink his allocation to emerging markets. "But it could take for years to get something worked out," he says.

For Zamora, the election isn't make or break for emerging markets, but people should add the election as yet another risk factor to investing developing nations. There could be short-term losses if Trump wins, and especially now with many people thinking he won't, but longer-term, investors will have to wait and see just how the post-election process plays out.

"Nothing's going to change the day after," he says. "These things have to play out over a significant period of time."

By Bryan Borzykowski, special to CNBC.com