Marcus Svedberg of East Capital -
The outlook for the global economy may seem very dark after the World Bank and International Monetary (IMF) meeting in mid-October, but there are actually good reasons to be optimistic.
Even though there are large differences across our investment region going forward, when breaking down facts and figures, six countries – larger markets as well as smaller ones – stand out as winners.
The autumn meeting of the World Bank and IMF in felt like a rather depressing get-together for the ten thousand economists and policymakers that assembled in Tokyo for a week of discussions.
The reason for the gloom is that the global economy is slowing down and most forecasts have been revised down. The IMF now believes world output growth will reach 3.3% in 2012 and 3.6% in 2013. This is 20 and 30 basis points lower than the forecast made in July, which in turn was lower than the one in April. All major economies, except for the US, which is rather flat and has started to surprise positively on employment and housing, are contributing to the slowdown and the downward revisions. Not even emerging economies have been able to withstand the slowdown. The meeting also raised alarm over the negative consequences of too much fiscal tightening and deleveraging in the rich world.
It is easy to get carried away by the gloom, but experienced IMF-goers found the Tokyo event more upbeat than last year's exercise. And there are actually good reasons to be optimistic.
Reasons to be cheerful
Firstly, and perhaps most importantly, the tail risks have fallen dramatically as a result of the recent policy response in Europe
in general and the European Central Bank (ECB) interventions in particular. There is now a real backstop and the risk of a collapse of the Eurozone is very small. Moreover, most analysts believe US policymakers will get their act together to prevent the US from falling off the fiscal cliff next year.
Secondly, growth has bottomed out, or is very close to doing so. Growth in the third quarter surprised on the upside in the US, while China most likely passed a trough. Even the Eurozone may have passed the bottom, although the recovery is expected to be weak. Moreover, inflation will not be a problem in any of the larger economies next year. The IMF believes it will fall by 30 bp in developed and emerging economies, to 1.6% and 5.8% respectively in 2013.
Thirdly, it has not really been a bad year in the world of finance, and the outlook is actually quite good. Most bond, equity and commodity markets have performed this year, and quite a few have noted double-digit gains. Recent announcements of continued monetary stimulus from the major central banks in the world suggest that the party, especially for equities, has only just started.
CEE - from recession to buoyant growth
What does all of this mean for Central and Eastern Europe? The first point is that the general outlook for CEE is closely linked to the global development. Most economies in CEE have weakened on the back of the slowdown in the Eurozone, but growth may already have bottomed out in most countries. Inflation will fall even further and there is room to stimulate growth through monetary and fiscal policies in most economies.
The second point is that there are big differences across the region. The European Bank for Reconstruction and Development (EBRD) believes average growth will increase from 2.7% in 2012 to 3.1% in 2013, but the weakest economies are expected to remain in recession, while the most buoyant experience double-digit growth. The problem is that the recovery in 2013 is expected to be weak in the most vulnerable countries. The low external demand combined with bank deleveraging in the Eurozone mean that the economies that are most integrated will not be able to recover quickly. A handful of countries in the region will likely post negative growth in 2012 - Slovenia, Hungary, Czech Republic, Croatia and Serbia - and they will probably not grow more than 2% in 2013. The other new EU members will probably grow faster, but few will manage more than 3%, which is only marginally faster than this year. And some, such as Poland and Latvia, may even continue to contract, albeit from relatively high levels. The Russian economy is slowing down but should be able to stabilise at around 3.5%. The other Commonwealth of Independent States (CIS) economies, which tend to be the least dependent on the Eurozone, should maintain growth at around 5%. The Turkish economy has managed to slow down in an orderly manner, and growth is expected to pick up from 3% to 3.5% next year.
There are no general economic imbalances in the region. Particular countries may, however, have particular problems that could cause economic or financial pressure. Inflation will remain a problem in Belarus, while Georgia and Turkey will continue to struggle with high current account deficits, which may put pressure on their currencies. The main risk for the region in general and the new EU members in particular remains the Eurozone. The tail risks have decreased, but financial deleveraging can still cause problems. Politics remains a tail risk in some of the least -developed countries - most notably Belarus, Bosnia and parts of Central Asia - even though the status quo could be maintained for years.
The vast majority of markets in CEE were in positive territory after the first three quarters of 2012 and the regional benchmark index was up 16.8%. There were, however, enormous differences in performance from quarter to quarter as well as within the regions. The Russian market, for instance, gained 18.5% in the first quarter but then dropped 17.5% in 2Q, before gaining 9.3% in the third. The difference between Turkey, which is the best market year to date, and Ukraine, which has underperformed throughout the year, is an astonishing 70 percentage points. Currencies have been volatile, but few have moved more than 5% this year. The HUF, PLN and TRY are the strong exceptions, while the RSD depreciated by more than 5%.
A valuation model from UBS suggests that there are also large differences across the emerging world going forward.
Of the larger index markets, Russia is second only to China, while Turkey and the Czech Republic are among the top five in the world as well. Poland and Hungary, on the other hand, are at the bottom. Of the smaller markets, Bulgaria and Serbia are deemed the most attractive, and Kazakhstan is also in the top league. Lithuania, Estonia and Slovenia, on the other hand, are at the bottom.
These technical models should be interpreted with some caution, but that Russia and China should be able to outperform going forward also makes intuitive sense. They have underperformed year to date due to misplaced concerns (politics in Russia and economics in China), and are traditionally beneficiaries of monetary stimulus. It is possible to make the reverse case for markets like Hungary and Poland. They have outperformed so far this year, but have a more challenging economic and/or political near-term outlook. Other markets, such as Turkey, are more difficult to analyse based on performance and near-term economic and political outlook, and may therefore trade more on valuations and news flow.
There is a lot of upside from a valuation point of view in frontier markets like Bulgaria, Serbia and Kazakhstan, which have underperformed this year. It is obviously more difficult to say when these markets will revalue, but the recent rally in Slovenia (the market gained 20% in September on privatisation rumours) suggests that a revaluation can happen rapidly when there is a general risk-on mood combined with a specific trigger.
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