There are numerous factors currently acting as significant headwinds in global financial markets. Rising interest rates, geopolitical risks and an increased risk of recession to name a few. Perhaps no other issue is having the immediate impact though as the current war on trade. Since the U.S. began ratcheting up the trade war with China this past year; there has been a significant divergence between the U.S. and emerging market equities. In fact, as of late October, the benchmark S&P 500 was up some 4.7% while the MSCI index declined by over 14%.
When did it Start?
Although analysts may be quick to blame the trade war for this divergence, it actually started well before. Since the Great Financial Crisis of 2008, the S&P has seen triple-digit returns while the MSCI index is still over 10% below the previous peak. The divergence between U.S. and emerging markets really became pronounced in about mid-2011.
What’s Causing the Divergence?
There are numerous factors at play and no single catalyst for what is being seen currently across global financial markets. The causes are both cyclical as well as structural in nature. One of the primary cyclical catalysts, however, was without question the massive amount of quantitative easing that was pumped into U.S. markets over the last decade or so. This QE fueled a significant rise in asset values and some analysts have suggested that it was the main factor in stocks rising so sharply over the last decade.
Could it Continue?
The short answer is yes. U.S. stocks have enjoyed the benefit of a growing economy along with massive stimulus. Emerging market stocks, however, have not enjoyed the same growth. In fact, many emerging market economies have contracted over the last several years making a widening of this divergence a strong possibility.
Authoritarianism, Populism and Nationalism
The ever-changing world of geopolitics has and will continue to play, a major role. The trade war is just one symptom of these issues taking hold. Nations such as Russia, China and Turkey are all more or less authoritarian regimes pursuing nationalist agendas. Western nations, such as the U.S., Great Britain and Italy are having issues of their own. Trump’s “America First” policies, Brexit and Italy’s budget issues are all primary examples. These regional agendas may make it increasingly difficult for emerging market economies to compete, as they rely heavily on developed nations for technology, investment and open market access.
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