Nicholas Watson in Prague -
In these stormy times, the question for investors is where best to park your money until the weather improves? Overall, there is growing evidence of a decoupling between the mature economies of the West and those in the emerging markets of in Central and Eastern Europe. And within the region, Austria and Poland look the safest bets for the short term.
In simple terms, GDP growth in CEE will far outstrip that in the Western Europe and the US. The International Monetary Fund is widely reported to have slashed its forecast for US economic growth this year to 0.5% from 1.5% in its upcoming World Economic Outlook report to be released on April 9, while the institution is expected to say the economy of the 15 countries using the euro will grow less than 1.3% this year.
By contrast, economists overwhelmingly expect most emerging economies, including those across emerging Europe, to remain quite strong. "Most emerging economies appear likely to maintain quite strong, albeit somewhat slower, growth," Economists at the Washington-based Peterson Institute said in an April report.
In Central Europe, official forecasts put Poland's economic growth at around 5.5% in 2008, Czech Republic at 4.1%, and Slovakia at 7.4%. Hungary is the standout loser in the region, with the government lowering its 2008 GDP forecast to 2.4% from 2.8%, but even that's high compared with the anemic growth in the US and Western Europe. Further east, Russia in March revised its official forecast for 2008 GDP growth up from 6.7% to 7.1%, while Ukraine expects growth to come in at 6.8% this year.
More anecdotally, the Centre for European Economic Research (ZEW) and Erste Bank's economic sentiment indicator for CEE - calculated by taking the balance of positive and negative assessments of 70 financial market experts over the economic outlook for the next half year - rose again in March for the second month in a row. "Not a single financial market expert views today's economic environment in the region as bad," the authors of the report wrote.
Marginally safer haven
While there is much evidence that mature market economies and those of emerging markets are decoupling, the case for whether the equity markets are also decoupling is less solid. "You could argue that emerging markets should be seen as more of a safe haven than we have indeed witnessed, but we aren't ready for full stock market decoupling yet," says Gus Robertson, senior portfolio manager of emerging markets equity at ING Investment Management. "Perhaps over the next six-12 months, if we see stability in Russia and other markets hold up very well and show strong growth, then perhaps investors will come back, saying 'yes we believe in these markets.'"
What is surer is that the stock markets in the West haven't hit rock bottom yet and markets across the globe will remain volatile for some months to come. Much of that has to do with the continuing fear of another Bear Stearns - the US investment bank that collapsed and had to be offloaded to JPMorgan Chase for less than its grand Manhattan HQ was worth. Fitch Ratings, in its latest semi-annual "Bank Systemic Risk report" issued April 7, says that banks worldwide face an increasingly challenging operating environment. "Bank systemic risk continues to rise, the US and Swiss banking systems have weakened due to the US sub-prime crisis, and a sharp fall in global credit growth is underway." Yet even though the US and Swiss banking systems have been toppled from their top, "very strong" ranking based on Fitch's Banking System Indicator, they are still on a par with most developed country banking systems which remain "strong."
"In the US, losses and write-downs to date, while still mounting, fall well short of aggregate system capital - a conventional measure of the severity of a banking crisis," says Richard Fox, senior director in Fitch's sovereign team. "But global real credit growth is forecast to slow sharply to 9% this year, from over 14% last year, and leading indicators of potential stress are flashing in more emerging market regions."
If there are no more catastrophic banking failures, then the markets should probably move sideways during the second quarter, with CEE markets expected to experience some slowdown in growth, mostly in line with maturing business cycles. "Austria and Poland are seen as the best places to wait for better weather," reckons Henning Esskuchen, co-head of CEE Equity research, at Erste Bank. "Within Southeast Europe, we would remain cautious, but see Romania as the first one to benefit from any broader recovery, once investors are willing to tap smaller markets again. For Russia and Turkey, risk aversion will need to improve considerably before these markets become more favorable again."
Justifying its view, Erste notes that Austria's estimated 2008 price/earnings ratio of 10 times is significantly below its historical average of 12.9 and the current spread between the benchmark yield and earnings yields of 5.9 is far above the historical average of 3.4, indicating the risk premium for Austrian equities is overdone. "CEE growth channeled into the Austrian market will remain appealing," it says.
Compared with other CEE markets, Erste says Poland might appear a bit "expensive" on a 2008 price/earnings ratio of 15.4. However, "under current circumstances, liquidity and size remain strong arguments and Poland remains second after Austria with an average daily turnover of €253m in 2007. "Assuming a bottom in the second half, the depth of the market could be another argument, in a way that it offers sound second-line ideas among small and mid-caps."
Tomasz Korab of Opera funds in Warsaw agrees: "Poland is relatively safe - safer than anywhere else. In Poland the main investment is in infrastructure and that's independent from the overall economic story. If you're just looking at the private sector, then if there's a slowdown, companies stop investments quite quickly. But when you are talking about infrastructure and it's planned, I think it's completely independent and will be co-financed by the EU."
Meanwhile, Erste says Slovenia and Croatia remain the most demandingly valued markets. "Local liquidity should be able to lift prices occasionally again, but within the current environment of risk aversion, investors are recommended to stay away, even though a few stock picking opportunities (Krka, Gorenje) prevail," it says. While the Southeast European markets in general still have some selective stock picking opportunities, "the market overall has still a lot of vision priced in and vision does not sell well these days," it says.
For the two big markets in the region, Turkey and Russia, Erste sees as pretty similar: more neutral weight. "The change in [Russia's] presidency went smoothly and the political programme recently announced sounds business friendly. As long as uncertainty remains, investments in commodities might remain an option, assuming that recession fears do not massively steer sentiment," it says.
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