EM equities and bonds took a hit immediately after the U.S. election, as investors feared the new administration would be negative for global trade and capital flows. As the chart shows, industrial metals and other commodities quickly rebounded on hopes for increased infrastructure spending and amid signs of a pick-up in global growth.

Scope to play catch up

EM assets have stabilized somewhat but lagged a recent rally in commodities. Our conviction is that U.S.-led reflation — rising wages, nominal growth and inflation reinforced by an expected shift to fiscal stimulus – should be a big positive for many EM assets. Greater infrastructure spending should boost demand for the commodities exported by EM producers.

Risks abound in the short term, including a sharper rise in U.S. Treasury yields and the U.S. dollar as well as a quicker fall in China’s yuan. But we believe a gradual Federal Reserve, wary of tighter financial conditions, should limit dollar gains from here. Over the past three years, EM assets have already weathered an economic downturn and dollar appreciation: Currencies are weaker and current account balances are generally in better shape. Commodity markets, a key source of earnings for many EM companies, have found a better demand/supply balance — including crude oil after OPEC’s decision last week to cut supply.

We like selected commodity-producers but are wary of manufacturing countries vulnerable to a tougher U.S. stance on trade. We prefer countries where structural reforms show a willingness to sacrifice short-term economic pain for long-term gain, such as India’s move to eliminate high-denomination banknotes. Finally, we prefer hard-currency EM bonds — particularly in high-yielding oil exporters such as Russia, Colombia and Kazakhstan — and short-duration local currency bonds in some countries.