EM assets are well positioned to benefit when more favourable trade winds return
By Kamakshya Trivedi, Chief Emerging Markets Macro Strategist at Goldman Sachs/ Financial Times.
Since 2011, global trade growth has been stagnant. With protectionist sentiment intensifying in the US and Europe, and with China appearing to pivot away from export-oriented growth strategies, a hypothesis informally known as “peak trade” has become increasingly popular. According to this view, the past five years of stagnant trade growth is not temporary, but instead reflects fundamental changes to the global economy that will drive continued stagnation in global trade over the next decade and beyond.
This view has important implications for global asset markets in at least two ways. First, trade is often seen as an engine of global growth, and the sputtering of this engine over the past five years (and the idea that it has permanently stalled) has been widely interpreted as an important reason to be sceptical of global growth in the long run — a view that is baked into the very low levels of long-dated bond yields in advanced economies. Second, peak trade implies long-run pessimism for the assets of economies particularly dependent on trade, including many emerging markets.
Our recent work, however, pushes back against three key variants of the peak trade hypothesis.
First, it has been noted that the measured sensitivity of trade growth to GDP growth — the “trade beta” — has fallen from above 2 in the early 2000s to near, and even below, 1: the value at which global trade growth simply keeps up with global GDP growth. However, a detailed look uncovers little convincing evidence that trade has become less responsive to growth over the past 20 years. For example, shifts in the measured trade beta fit awkwardly with shifts in global trade growth: estimates of the trade beta increased in the late 1990s (as trade stagnated), then fell dramatically in the early 2000s (as trade boomed), suggesting that we should not read too much into these large recent fluctuations in the measured “trade beta”.
Second, the global trade slowdown of 2011 was more severe than predicted by observable short-run shocks, prompting many to conclude that forces operating over very long time horizons, and with the potential to drive trade growth still weaker in coming decades, have driven the slowdown. However, we track the nearly 400,000 separate trade flows over the past 20 years, and find their growth rates have returned to baseline levels that, while low, are close to their longer-run histories. In other words, 2011 was not the beginning (or the middle) of a downward deviation from a 70-year trend of globalisation, but instead marks the end of a decade-long upward deviation from this long-run trend: the trade boom of the 2000s.
Third, many observers suggest that, by beginning to turn away from export-led growth models, EMs — and, especially, China — have driven the trade slowdown and will weigh on trade growth in coming decades. However, we find that a slowdown in the demand for tradeables (not an EM-led turn away from exports), especially in Europe (much more than China), played the most prominent role in driving the trade slowdown. In its most recent WEO report, the IMF reached a similar conclusion about the importance of demand in explaining the trade slowdown. In sum, shifts in global demand will continue to shape how trade evolves in the years ahead.
Our arguments do not call for a speedy rebound in trade growth, but in our view the distribution of risks to global assets has been too heavily influenced by the idea that positive impulses from trade will never return. In particular, while extreme pessimism on global trade has bled significantly into long-run pessimism on global growth, our work uncovers little to suggest that this type of outcome should be seen as the most likely scenario.
Consequently, we push back against the structural negativity around EM assets that we encounter and are more constructive (as we have been since late 2015). Despite their vulnerability to a long-run stagnation in global trade growth, we think such risks are overemphasised and that EM assets — characterised by much improved external balances, high real yields and unchallenging valuations — are well-positioned to benefit when more favourable trade winds return.