One week / one topic: Tropicalia

What happened?

Ahem, where to begin?

Tariff letters, ‘Big Beautiful Bill’ and related fiscal concerns, US jobs ruling out any Fed cuts in the near term, UK fiscal drama, military escalations… there is really no shortage of headline-grabbing developments.

And yet, the market just does_not_care. The S&P 500 has gone up almost vertically, now +30% since the April lows.

As stated last week, we were inclined to pursue opportunities in the emerging markets equities space due to a series of considerations:

• The US situation is unpredictable by design. It’s impossible to know what’s coming next, and equally impossible to guess when the market is going to care and about what

• Given the above, most investors are actively reconsidering their longstanding (still) large overweight allocations to US assets. Granted, the US is home to some fantastic businesses, but confidence is hard to rebuild once it cracks

• A number of emerging markets sport attractive valuations, boosted by the fact that several local central banks have done a better job in managing the post-pandemic rise in inflation vs their DM peers.

Of course, one important caveat is that ‘country risk’ considerations dominate almost anything else when it comes to emerging markets assets.

In other words, cross-asset correlations are much higher than in developed countries since macro and policy risks are seen by investors as impacting all domestic assets simultaneously.

Putting it all together, we have been further building our positions in Brazilian, Turkish and Chinese assets as we believe there are attractive opportunities on hand.

But why, and how, and how much? And what about tariffs, wars, local risks… Are you sure?

"You take the blue pill – the story ends, you wake up in your bed and believe whatever you want to believe. You take the red pill – you stay in Wonderland, and I show you how deep the rabbit hole goes." (Morpheus to Neo in “The Matrix”)

Take the red pill, shall we?

Our observations

• Fundamentals:

  • Brazil: Ex-ante real yields of ~10%, undervalued currency, double-digits equities earning yields, potential for political reform with elections next year and low foreign positioning.

  • Turkey: The tailwinds of economic and political reform are hampered by political volatility, but sky-high nominal yields and ~20% equities earnings yield might well be enough to compensate you for the currency depreciation… managed or otherwise.

  • China: While bond yields keep going down due to growth and demographic concerns, policymakers seem to have turned a corner in terms of propping up equities at a time when valuations remain reasonable.

• Price action: In general, emerging markets assets have historically experienced multi year rallies – so it pays to be vigilant. (see chart below, same as last week).

• Investor beliefs: As narratives follow price action, further gains might indeed help consolidate the drive to diversify away from US assets… stay tuned.

So what?

Both Brazil and Turkey do not have large trade surpluses with the US, and so we think hope they should be less vulnerable to further tariff-induced volatility from here:

• In Brazil, we own positions across equities, 7y govies and FX as we want exposure to the whole asset stack

• As for Turkey, we own broad-based equities and supranational bonds.

While China is of course front and center of the trade dispute with the US – and more broadly, deeply entangled in Thucydides Trap dynamics – Paul Getty’s quip comes to mind: “If you owe the bank $100, that's your problem. If you owe the bank $100 million, that's the bank's problem”.

In other words, how much can the US realistically extricate itself from its symbiotic relationship with China?

While of course we don’t know the answer, for the time being we maintain a small allocation to Chinese equities with a view to potentially increase it should the market become overly pessimistic about their prospects.

Mood music: TOTO – Africa