'Sell America' trade is a 'paradigm shift', says PIMCO's Pramol Dhawan

Emerging Markets Investment Playbook: A Paradigm Shift

Key Concepts:

• Dollar Reversal: End of a long-term dollar appreciation trend.
• Diversification: Shifting investment focus from US assets to international markets, particularly emerging markets.
• Multi-Polar World: A global economic landscape with multiple dominant economies (US, UK, Europe, Japan, etc.), leading to lower overall growth.
• Fiscal Stimulus: Government spending to boost economic activity.
• Near-shoring: Relocating business operations to nearby countries.

1. The Dollar Story and Emerging Markets

• The primary driver for emerging markets is the reversal of the dollar's multi-year rise, not just tariff barriers.
• For a decade, the US ran large deficits while other countries saved and recycled surpluses back into the US, pushing the dollar and US asset prices up.
• Since "Liberation Day," this trend has reversed, marked by a decline in the negative correlation between US assets and the US dollar.
• This negative correlation is rare (less than 4% of occurrences) and painful for international investors as they lose on both US equities and the dollar.
• Investors are now forced to consider diversification and reduce their dollar holdings, bringing emerging markets back into the investment conversation.
• Emerging markets are attractive due to healthy balance sheets and being an under-owned asset class.

2. A Paradigm Shift: Moving Away from US Dominance

• The shift away from US assets is not a temporary blip but a paradigm shift.
• Historical dollar cycles have seen significant moves (25-30% in the mid-80s and early 2000s). The current move is only 5-7%, indicating further potential.
• The MSCI World index is heavily weighted towards US corporations (70%), meaning the world is heavily invested in US assets, particularly US equities.
• The need to hedge and rethink allocation to US equities is driving the shift.
• In a multi-polar world with lower structural growth, investors should reduce equity exposure, increase debt holdings, and shift from dollar assets to international assets.
• Diversification is emphasized as the key benefit in this new market environment.

3. Mexico's Position in the Changing Landscape

• Mexico is in a favorable position as it was largely spared from punitive tariffs.
• However, Mexico's economy is heavily tied to the US and dependent on the US-China trade situation.
• If current tariff levels (125% reciprocal, up to 245% on certain goods) persist, Mexico will not be immune to the negative impact on the US and Chinese economies.
• While near-shoring benefits may exist in the short term, the overall economic drag will affect Mexico.
• If US-China tariffs are reduced to "normal" levels, Mexico is well-positioned as a low-cost producer and a preferred near-shoring partner for the US.

4. China's Strategic Response to Trade Tensions

• China strategically avoided a large currency depreciation, which was the market's expectation.
• Instead, China opted for a large fiscal stimulus and some monetary stimulus to support its economy.
• China has ample room for fiscal stimulus.
• This approach aims to create a floor under the Chinese economy.
• However, if trade tensions persist, even China cannot be completely shielded from the economic decline.

5. Conclusion

The interview highlights a significant shift in investment strategy, driven by a weakening dollar and a move towards diversification in a multi-polar world. Emerging markets are poised to benefit from this shift, but the ultimate impact will depend on factors like the resolution of US-China trade tensions and the specific economic policies adopted by individual countries. The key takeaway is that investors need to re-evaluate their asset allocation and consider reducing their exposure to US assets in favor of international opportunities.