Looking for bright spots in Emerging Markets

US tariff changes continue to create uncertainty. The 90-day pause on tariffs, except for China, and the announced exemptions illustrate the unpredictability of US trade policy. What might unfold between now and the end of the 90-day pause in July remains unclear.

That aside, the current effective US tariff rate is still close to 20%, up from 2.4% last year. This will increase inflation, reduce consumption by reducing real incomes, and damage business investment spending in the US. As such, US growth is expected to come in at sub-1% this year with a negative effect on corporate earnings. This slower growth is likely to persist into 2026.

With US equities still priced at a premium at a 12-month forward price to earnings ratio of around 20x, sub trend US growth for the next 12 to 18 months suggests that US equities should de-rate to at least its 35-year historical trading average of 18x. Given the significant weightings in US equities among global portfolios (See Fig. 1), investors are likely to seek greater diversification.

Fig. 1. Investors are massively OW US equities

Source: Federal Reserve. HSBC. April 2025.

We believe that Emerging Markets (EMs) are well-positioned to attract some of these flows. For one, valuations are very cheap relative to the developed markets (DMs) (Fig. 2). We could also be at an inflection point where the growth differential between EMs and DMs stabilizes and potentially widens. Historically, EMs have outperformed DMs when this growth differential rises. See Fig. 3.

Fig. 2. MSCI EM relative to MSCI World trailing PB(x)

Source: MSCI. Refinitiv Datastream. Eastspring Investments. As of March 2025. Notes: PB = price to book. DM is MSCI World Index. EM is MSCI Emerging Market Index.

Fig. 3. EM vs DM: Relative performance vs growth differential

Source: FactSet, Goldman Sachs Global Investment Research. 7 April 2025.

Amid the recent heightened market volatility, it is interesting to note that the US dollar has declined 8.3% year to date, while other typical safe havens like gold and the Swiss franc have appreciated 26.0% and 10.0% respectively. With the Federal Reserve more likely to cut than to lift interest rates as US growth slows further, and given President Trump’s desire for a weaker dollar, a peak in the USD would be positive for EM assets, as long as investor risk appetite holds. Historically, EMs and the USD have shared an inverse relationship. Fig. 4.

Fig. 4. Emerging markets go up when the USD goes down

Source: Bloomberg. April 2025.

A weaker USD could boost higher carry EM currencies. It could also provide more room for rate cuts given EM central banks’ concerns about exchange rate stability and passthrough to inflation. We note that policy is already rapidly easing in Asia following recent moves by policymakers in India, Korea and Singapore. We expect the Bank of Korea and Bank of Thailand to cut rates again in the coming months. We see plenty of scope for easing in non-Asia EM too. A weaker USD could provide a positive feedback loop between lower rates, higher economic growth and capital inflows for EMs.

While few countries have been spared from the US’ tariffs, there are relative winners within EMs. We are focusing on countries that can deliver policy stimulus to offset some of the tariff shock and markets where company specific factors are pushing up return on equity. In earlier commentaries, we had highlighted the potential for India and China to navigate the tariffs. We focus on Latin America (LatAm) and Central & Eastern Europe, Middle East and Africa (CEEMEA) in this article.

Prior to the 2^nd April tariff announcements, LatAm currencies had depreciated more than those of EMEA and Asia. On a year on year basis, LatAm currencies have depreciated 15% against the USD, while EMEA and Asia FX have fallen 4% and 2.5%¹. This was partly due to market expectations that the LatAm countries were going to be among the hardest hit by the tariffs within EMs. LatAm’s high goods revenue exposure to the US also exacerbated market concerns. Fig. 5.

Fig. 5. EM countries' revenue exposure to US

Source: FTSE Russell, Factset, HSBC. 20 February 2025.

However, the tariff announcements to date suggest that LatAm is a relative winner in the EMs. For one, the absence of incremental tariffs (at the point of writing) on Mexico was a positive surprise. For now, there are no tariffs on USMCA compliant goods; and while the US has slapped a 25% tariff on non-compliant goods; future exemptions could lower the effective tariff rate to 12%. Given the higher tariffs imposed on other manufacturing locations, the near shoring theme appears intact and should be positive for Mexico.

Brazil should also be less impacted by tariffs given its relatively closed economy – 80 to 85% of GDP is domestically driven. Historically, Brazilian equities have benefited from a weaker USD and lower rates. With the Brazilian and Mexico equity markets trading well below their historic averages, at 7.7x and 11.4x 2025 price to earnings respectively, we are finding fertile ground to find high quality names at depressed valuations. In particular, we like rate sensitive names in Brazil.

The CEEMEA region is also relatively less affected with a GDP-weighted average tariff of 11.4% although there is variability within the region. Reciprocal tariff rates for the larger markets in the Middle East like Qatar, Saudi Arabia and UAE are at the lower end at 10% although the region is expected to be hurt by lower oil prices. For Turkey, the outlook for Europe matters more as it exports more to the European Union (8.2% of GDP) than the US (1.2% of GDP). At the same time, Turkey could benefit from reshoring of manufacturing from China.

The CE3 economies (Poland, Czech Republic, and Hungary) face 20% tariffs that are consistent with the EU's rates. Both Poland and the Czech Republic have less than 1% of their revenues tied to the US, while Hungary, with approximately 1.6% of its revenues dependent on the US, is the most vulnerable due to its substantial auto manufacturing industry. Meanwhile, South Africa’s 30% tariff rates could end up lower following exemptions.

EMs’ attractive valuations and increasing favourable growth differential versus the DMs position it well to benefit from a weaker USD and potential diversification flows away from US equities. While few countries have been spared from the US’ reciprocal tariffs, there is significant variability within EMs in terms of exposure to US revenues, potential market share gains/losses and central bank responses. This backdrop presents significant opportunities for active managers to add value. EM investors are no strangers to market volatility. We are accustomed to navigating the complexities and fluctuations inherent in these markets. As such, amid the market volatility, we continue to focus on delivering long-term alpha by staying disciplined and uncovering high quality names at depressed valuations.