In July, the Strategy outperformed the MSCI Emerging Markets index by 0.6%, during another positive month for the asset class.
The largest relative contribution came from our still significant underweight in the Indian market, which has lagged EM equities. We also had a strong contribution from our Greek banks and Middle Eastern positions. On the flipside, parts of our Korean portfolio suffered from profit-taking after a very strong run during the first half of the year.
We have continued reducing our exposures in Poland and the UAE, where we have seen a significant re-rating in some of our stocks. This has allowed us to add to some existing positions in China as well as topping up exposure to precious metals. India remains a large underweight, but we are following the ongoing market digestion of extremely high valuations and remain on the lookout for opportunities while mindful of geopolitical headwinds.
Over the past months, market participants have been poring over economic data for clues on the impact of tariffs. This has largely been a futile exercise as the first months of the year were distorted by front-loading of trade and building of inventories in the US. This was followed by companies leaning on those inventories to maintain pricing and wait for clarity. We are only now likely to start seeing a pass-through into the global economy. The US$30bn collected by US customs in July (up from a $6bn monthly rate at the start of the year) is likely to grow further based on currently known tariff rates. Most directly, this is paid by US importers, but the bigger question is how that cost is then spread among consumers and suppliers.
Consumer price inflation in the US has remained subdued so far, which suggests only minimal price increases. A Bloomberg analysis shows that import prices for US firms have increased roughly in-line with tariffs, suggesting their suppliers have not reduced prices to absorb tariffs. Latest increases in PPI data support this view. This implies US companies initially taking most of the hit on their margin – tariffs have so far essentially been a US corporate tax increase. A weakening US dollar has further exacerbated this situation. This tallies with our discussions with Asian suppliers of electronics, shoes and textiles that confirm no pressure to cut prices from US clients for now. From an EM perspective, this would suggest a goldilocks scenario where US end-demand remains steady while supplier margins are protected, courtesy of US profit margins.
Naturally, we do not believe US importers will simply accept this situation. As pre-tariff inventories run low, they will gradually have to adjust prices or push back on suppliers. Given retail prices are significantly higher than those paid to international suppliers, passing on tariff costs to consumers may be easier. Nike shoes imported from Vietnam at $15 a pair can retail for $150 in the US. If the 20% tariff on imported shoes is passed on to consumers, it might only increase prices by 2% – this is below annual US inflation. On the other hand, reducing the supplier price by $3 might make it unprofitable for them to produce.
Similarly, the cost of Brazilian Robusta coffee beans in a $5 Starbucks Latte is around 10c. Passing on the current 50% tariff on to consumers would raise its price by 1%. This is likely to be easier to pass on than developing a whole new supply chain with non-Brazilian coffee beans.
Over the coming two quarters we are likely to see more clarity as inventories run down and we start reverting to business as usual. Any reported changes to trade flows, inflation and growth may become more meaningful indicators of the new reality. While there are likely to be plenty of unintended consequences and twists, as long as policy stabilises somewhat, the impact on our markets may remain muted.
