Emerging markets are also thriving as the Trump trade lifts all boats

A teller at a money changer handles Indonesia rupiah bank notes in Jakarta, Indonesia November 11, 2016.
Darren Whiteside | Reuters
A teller at a money changer handles Indonesia rupiah bank notes in Jakarta, Indonesia November 11, 2016.

Emerging markets still offer opportunity for investors, several strategists say, as President-elect Donald Trump's election upset will only pause —but not end—the asset class's recovery this year.

"Our view is the market is overreacting and that the truth and reality is somewhere in between (where) you may continue to get a strong dollar with economic growth," said USAA Investments Head of Global Multi-Assets Wasif Latif, who has $9.35 billion in assets under management. He turned slightly overweight on emerging markets from neutral early this summer.

"If anything, our next move will be to full overweight, but it could be many years down the road," he said. "We're not reacting to our positions the way the market is."

Concerns of a trade war, near 14-year highs in the Dollar Index, and multi-month highs in Treasury yields have prompted an immediate sell signal for many investors in emerging markets.

The iShares MSCI Emerging Markets ETF (EEM) has fallen more than 7.5 percent since the election, while the S&P 500 is nearly 2 percent higher. The Dow Jones industrial average and Nasdaq composite have climbed more than 2 percent, touch record highs just a few days ago.

However, the greenback's strength is particularly negative for emerging markets, whose holdings of dollar-denominated debt become more expensive to pay off when their currencies weaken. This week, authorities in Indonesia, Malaysia, India and South Korea intervened directly or indirectly to stem sharp slides in their currencies, according to published reports by The Wall Street Journal, Bloomberg and Reuters.

"If the dollar goes up this tends to hurt emerging markets," Isabelle Mateos y Lago, a global macro investment strategist at BlackRock Investment Institute, said on CNBC's "Squawk Box" Friday. She is overweight emerging markets.

"But emerging markets are much less vulnerable to these developments than they were in the past," she said. "They have lower dollar-denominated debt, they have very strong fundamentals of their own, [and] they have scope to ease monetary policy if need be. And they've been powered by very strong inflows."

Emerging market equity funds have seen inflows of several billion a month since July, but those trends reversed in the last three weeks and accelerated after the election. Those funds saw $5.4 billion in outflows last week, the largest such decline since August 2015, according to EPFR Global. The firm also said emerging market debt funds saw a record outflow of $6.6 billion last week.

Source: EPFR Global.
'Digesting the change'

Still, the EEM is on pace to post its first positive year in four, up nearly 8 percent year-to-date after an 18 percent plunge in 2015. The S&P 500 is up about 6.8 percent for 2016 after ending only a touch lower the prior year.

"The market is digesting that change and potential risk of renegotiation of trade deals and rate hikes," USAA's Latif said. From a longer-term perspective, "valuation would tell you in the next 3 to 5 years [emerging markets] is going to be one of the strong performing asset classes."

The MSCI emerging market index had a price-to-earnings ratio of 14.94 at the end of October, versus 22.63 for the MSCI USA index.

Part of the confidence in emerging markets also relies on a view that Trump will have a softer stance on trade as president than during his campaign.

"The U.S. will never, never have the capacity to renegotiate the trade agreements," said Philippe Ithurbide, global head of research, strategy and analysis at Amundi, which has more than $1 trillion in assets under management. "Perhaps we are wrong," he said, but no major changes on trade policy is our "central scenario."

Trump has called for a 45-percent tariff on imports from China and deportation of undocumented immigrants, while threatening to withdraw the United States from the World Trade Organization—an outgrowth of the populism sweeping developed economies.

"Last time we had a surge in protectionism we had a war, massive decline in trade, massive recession worldwide," Ithurbide said. On the small chance that Trump does implement tariffs and anti-immigration policies, he said the U.S. economy would likely fall into "a deep recession" and global growth would slow to 2 percent or less.

On Thursday, Barclays said the strong dollar and potential Trump changes on trade policy contributed to its decision to turn tactically neutral on emerging markets.

But Keith Parker, global equity strategist, also said the firm would look for opportunities to buy dips.

"We continue to believe that [emerging market] equities have the greatest upside potential over the medium term, given relative valuations, potential growth and the relative valuations, potential growth and the relative cyclical position (outside of China)," he said in a note.