An $11.4 billion fund manager talks Trump, Russia, and China

Business Insider recently caught up with James Donald, the head of emerging markets at Lazard Asset Management, to hear about his predictions for the emerging markets in the year ahead.

Donald is also portfolio manager of the Lazard Emerging Markets Equity Portfolio, which has assets totaling $11.4 billion invested across 76 holdings.

In the interview, Donald discusses Russia, China, energy, and the challenges facing emerging market countries in 2017.

This interview has been edited for clarity and length.

Tina Wadhwa: What do you see as the major challenges facing emerging market countries in 2017?

James Donaldson: The major challenges facing emerging markets in 2017 are several risks which could lead to reductions in global economic growth or even market disruptions. These include the possibility of economic disruption in Europe that could result from anti-European Union parties continuing to win elections and referenda, the possibility of sharply‎ rising US interest rates, and the risk of economic difficulties or crisis in China that's probably related to credit. Finally, the uncertainties of the new Trump administration policies, especially if they embody significant trade protectionism, would be another major challenge.

Wadhwa: Is a hawkish Fed and a strengthening dollar going to hurt EM in 2017?

Donaldson: If US and global economic growth surprise the market and expand at a very rapid rate, there is a possibility ‎of a hawkish Fed. In those circumstances, the Fed could be forced to raise short-term US interest rates sharply and that might strengthen the US dollar. From what we know of the incoming Trump administration, there could be considerable infrastructure spending, which should increase US and global economic activity. However, the eventual spending may be less than investors are currently expecting and considerable deflationary forces continue to exist in the world economy. In that case, there might not need to be such a rapid increase in short-term US interest rates or in the US dollar.

Wadhwa: In your end-of-year commentary, you wrote that you expect that a gradual tightening by the Fed would be seen as a positive sign of confidence in the economy and would benefit emerging markets in 2017. Many on Wall Street believe that the Fed will adopt a more aggressive tightening however if/when President-elect Trump nominates more hawkish members to the board. What effect will this have on EM?

Donaldson: Aggressive tightening by the Fed would likely have a negative effect on returns for emerging markets equities. If interest rates are increased sharply and consistently for some while, this is likely to attract investment inflows to assets such as US Treasurys instead of towards asset classes such as emerging markets equities.

Wadhwa: President-elect Trump has adopted what can be seen as a confrontational tone towards China, speaking with Taiwan and threatening to declare the country a currency manipulator and potentially impose tariffs. How do you see this playing out, when does it start to hurt China? Is there a retaliation we should be prepared for?

Donaldson: An intensification of this tone into serious trade protectionist policy would be uncharted territory and probably negative not for just emerging markets equities but also for global developed markets and even US shares. ‎For instance, the dollars earned by those countries that export to the United States have typically come back in the form of US stock and bond purchases. The threat of tariffs and quotas could potentially undermine foreign investments in the US. In the medium and long-term, it would mean that US consumers subsidize certain US worker groups and that prices remain higher than they would otherwise be. This would result in restrained economic activity and might cause stagnant global markets.

Since the Trump administration has not yet taken office, we are still guessing what its real policies will entail. ‎Many world governments are also waiting to see what the Trump administration policies will be. Trump's comments on Chinese trade, currency manipulation, and his telephone contact with Taiwan to date have been highly unusual. ‎I believe that the Chinese are unhappy with these actions and comments but, so far, they apparently have not been inclined to retaliate. In my opinion, the Chinese government will avoid retaliation unless the Trump administration acts aggressively against China geopolitically and politically.

Wadhwa: What effects will Trump's proposed trade policies like protectionism, tariff and trade quotas, and immigration have on emerging market countries?

Donaldson: If significant tariffs are placed on emerging markets exports to the United States, ‎economic activity in the developing world could be negatively affected. This might well result in lower profits and therefore declining stock markets. Lower immigration could result in reduced worker remittances being made to emerging markets countries.

These effects would not be felt just in emerging markets countries. In my view, protectionist policies would likely reduce economic growth everywhere over time.

Wadhwa: Do you think the new administration will take a softer stance towards Russia with regards to the sanctions imposed post Crimea? And if so, do you see a lot of upside in Russia over the next 12-24 months?

Donaldson: It appears that the incoming administration has a very different view from the current US administration on Russia and might be inclined to modify sanctions which were imposed after Crimea. That would probably be positive for Russian equities which are, for the most part, not expensively valued. As a result, Russian equities could continue to perform strongly.

Wadhwa: OPEC struck an accord on coordinated output cuts. What's your view on energy prices over the next 12-24 months?

Donaldson: Although OPEC has agreed to output cuts, we are anticipating relatively modest increases in oil prices over the next 24 months. There are still excess inventories and OPEC may find it hard to maintain the cuts.

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