East Capital -

This editorial has recently been focusing less on what is happening in emerging Europe and more on what is going on in the rest of the world, and this one is no different. The reason for this external focus is that much of the development on the stock markets in emerging Europe is currently being driven by the economic and regulatory changes in Europe, the US and Asia.

We have been asking economists, investors and other experts if the outlooks for the global and regional recoveries have changed lately. The consensus, and it is surprisingly strong, seems to be that things have changed and probably for the better, but the level of uncertainty is very high. This ambivalence seems to be reflected in the financial press, in statements from policy-makers as well as in the wider commentary circles in general and, not least, on financial markets. It is difficult to discern a trend since markets are moving in different directions from month to month. The VIX index, which measures volatility on the market, fell steadily from around 25 in early February to 16 in mid-April, only to bounce back to 35 in early July before dropping to 22 in early August and, finally, to climb back to 26 by the end of the month.

There are a lot of questions out there and few clear answers.

Policy debates

Investors and policymakers alike may be excused for being puzzled, as economists and pundits have fundamentally opposing ideas on what needs to be done in economic policy terms.

Some, mostly American experts, argue for more stimuli (ie. more cheap money), whereas others, mostly but not only Europeans, call for austerity. These are the exact opposite recommendations.

It is thus tempting, but maybe premature, to draw the conclusion that we have seen the end of coordinated global policymaking and that countries and regions will act more in their own interests from now on. The problem with that view is that the global recovery still depends a lot on external demand in general and emerging markets in particular. That brings us to China. Market participants have pointed out that for the first time, news coming out of China seems to be playing a larger role for the market than news from the US. This is not decoupling the discredited notion that emerging economies are no longer dependent on mature economies, but rather a sign that the global economy is indeed interdependent and that emerging and developed economies alike play a role of the global economy. The Chinese do not seem too concerned about the state of their domestic economy, but more so about the role they are expected to play as the second largest economy in the world. They are trying to downplay this new-found economic status. This is certainly an interesting discussion and something we most likely will return to in the near future, as China is playing an increasingly important role for a number of countries in emerging Europe.

In the European time zone, there is a growing conviction that although most short-term indicators have improved, most of the structural issues remain or have even deteriorated lately, including debt in Western Europe, fiscal consolidation in most parts of Europe, and the need for structural reforms in emerging Europe. We do, however, still believe that there is enough political will to continue with fiscal tightening in emerging Europe, even though there has been some political noise lately in places like Hungary, Romania and Serbia. The underlying recovery, which we are seeing across the region, rests primarily on external demand, but the pick-up in industrial production is very strong and supported by statistics as well as anecdotal evidence.

Overall, the focus for investors on a global basis seems to have shifted from Europe towards the US and China, and this may very well be an important factor behind the change in sentiment lately. Investors are also likely affected by the recent regulatory changes, such as the Basel III proposals (positive for banks) and the Solvency II regulations (negative for non-OECD equities).

The uncertainty in the external environment may linger, but we believe it is as important as ever for long-term investors to stay focused on fundamentals rather than sentiment.