Two questions in particular are very much on the minds of asset managers that invest in emerging Europe, the Middle East and Africa: Will Greece leave the euro zone, and when will the U.S. Federal Reserve raise interest rates?
A Greek exit — or Grexit, as it’s becoming colloquially known — could have an even more devastating impact on world markets than the 2008 collapse of Lehman Brothers Holdings, some observers believe, while others insist that damage would be short term and contained.
Most agree that it would be better for all concerned if the economic union were to remain intact.
“A Grexit is unlikely as a vast majority of the Greek population and Parliament as well as the European Union leadership want to avoid it almost at any cost,” asserts Anthony Bor, director of emerging EMEA equity research at Bank of America Merrill Lynch in London. “But we have been warning about brinkmanship leading to high volatility before a final agreement.”
Pascal Moura, Deutsche Bank’s Dubai-based head of emerging-markets research, shares a similar view. “The factors driving progress in the Greek negotiations over the next few weeks will be deeply political, and a Grexit is now undoubtedly a significant possibility,” he contends. “Given the need for both sides to compromise, we expect headlines to only intensify between now and a last-minute agreement. Our core scenario remains for Greece to remain in the EU as for both sides a Grexit represents a scary journey into the unknown.”
And if an accord isn’t reached? “A Grexit might lead to some short-term volatility, but the markets have had a long time to think about it and have factored most of the risks related to high sovereign debt levels in other markets a while ago,” Moura says. “We would expect the health of the global economy and the oil price to ultimately play a more important role than the Greek situation, and we are constructive on both.”
But Bor maintains that such a departure “would undermine the long-term credibility of the euro zone, as a precedent for exit would be set.”
Then there is the issue of when the Fed will raise rates. Two years ago investors yanked money from emerging markets in a so-called taper tantrum after board members spoke of winding down the central bank’s program of quantitative easing. The prospect of the first rate increase in nearly a decade definitely has some market participants on tenterhooks, although many research directors believe the fears are overstated.
“A Fed hike now looks like a known unknown,” observes Alexander Kantarovich, who in October became head of research for Central and Eastern Europe, the Middle East and Africa at J.P. Morgan in London. “Markets are driven by surprises, and with the widespread expectations of a hike already baked in, it may turn out to be more a ‘tantrum lite.’”
Moura concurs. “A rate hike will be a risk event for the markets, but rate rises should be gradual and some adjustments have already taken place,” he points out. “A major sell-off remains unlikely.”
Nonetheless, money managers want to be prepared, and many will seek the insights and opinions of those on the sell side as these and other issues move toward resolution. The firm whose perspectives they value most highly is BofA Merrill, which for a third year running tops the Emerging Europe, Middle East & Africa Research Team, Institutional Investor’s exclusive annual ranking of the region’s best sell-side analysts. The firm earns a spot in 19 of the survey’s 20 sectors that produced publishable results, missing out only in Transportation.
Deutsche Bank returns at No. 2 with 15 positions. J.P. Morgan advances one rung to share third place with Morgan Stanley, which holds steady in that spot. These firms capture 13 positions apiece — that’s an increase of three for the former and two for the latter. UBS vaults from No. 8 to No. 5 after nearly doubling its team total, from five to nine.
Fifteen firms are represented on this year’s roster. Click on the Leaders in the navigation table at right to view the full list.
David Aserkoff, who guides the J.P. Morgan crew from third place to finish on top for the first time in Central & Eastern Europe, Middle East & Africa Equity Strategy, thinks money managers that invest in the region have little to fear from either of the two issues cited above.
“Our economists have been clear in saying that we expect Greece to stay in the euro zone. Both sides have more to gain from staying in than from a Grexit,” he insists. “However, in the event that Greece leaves, we expect little contagion on CEEMEA markets.”
For one thing, the London-based team leader says, this particular investor base is distinct — “much more special situations and total return oriented than emerging-markets equity oriented” is how he puts it. Plus, the economic overlap is small, with Greece being more closely linked to the euro zone than emerging Europe. Even the connection to developed Europe is small, with Greece accounting for only about 2 percent of the economic union’s real gross domestic product growth, Aserkoff adds.
Similarly, “we would downplay the impact of the first Fed hike on CEEMEA markets for a few core reasons,” he says. “First, most investors are expecting it. Second, the likely timing of the hike continues to be pushed back. Finally, our view is that the Fed will raise rates gradually and to a lower rate than most investors expect given the sluggish growth and lower inflation trajectory of the U.S. economy.”
The analysts are urging clients to overweight Central Europe and Turkey, on accelerating growth and attractive valuations, respectively, and they are neutral on South Africa and Turkey. The team recommends underweighting stocks in the Middle East and North Africa as well as Russia, primarily on oil price volatility.
However, there is a potential upside for investors to consider: “A tighter Fed could push up asset yields for MENA banks,” Aserkoff believes. “They could be the big winners from this.”
That’s true, says Yavuz Uzay, captain of the BofA Merrill squad that rises one rung to capture its first top appearance in Financials. “Potentially higher U.S. rates will be positive for most banks in the Gulf region, where currencies are pegged to the dollar and the monetary framework is indirectly set by the Fed,” he explains. “We believe Saudi Arabian banks are prime beneficiaries for this reason.”
Uzay and his associates are also bullish on financial institutions in the United Arab Emirates, thanks largely to rising sustainable dividends. Abu Dhabi Commercial Bank and First Gulf Bank are among the lenders that the London-based squad is urging investors to buy.
Beyond the banks little else seems promising in the region at the moment — especially now that the price of oil has begun to slide, according to Simon Kitchen, leader of the EFG-Hermes team that vaults from third place to land in the winner’s circle for the first time in Middle East & North Africa Equity Strategy.
“MENA markets, especially those in the Gulf, have become positively correlated with oil prices over the past year, so a fall in oil prices would be bad for those markets,” the Cairo-based crew chief says. “Economies in Morocco and Egypt will benefit from lower oil prices, and this should support their stock markets in the long run.”
Egypt’s economy expanded at a rate of 5.6 percent year over year in the fiscal first half, the government reported in May, but that torrid pace is not likely to continue, Kitchen says, because the country is being held back by an overvalued currency. “Unless the foreign exchange market begins to operate smoothly, we are unlikely to see lasting recoveries in the economy and the stock market,” he declares.
The researchers are also bearish on Saudi Arabia, at least in the near term. “We believe that Saudi Arabia is likely to underperform once it opens up to foreigners in mid-June. We see the market as expensive, at around 16 times forward earnings, particularly given the uncertainty over oil prices,” he explains. “However, in the long run the opening up of Saudi Arabia is a major development that will catalyze institutional investor interest in the MENA region.”
Another country whose long-term prospects appear bright even though the interim outlook is far less rosy is South Africa, where energy shortages and labor disputes have hampered economic growth for the past few years. The risk of rolling blackouts is likely to remain high over the coming year, reports John Morris, leader of the BofA Merrill squad that earns a third straight appearance at No. 1 in Southern/Sub-Saharan Africa Equity Strategy. “However, looking into late 2016 and early 2017, we expect increasing new capacity from both [public utility] Eskom and private sector sources — renewables and cogeneration — to help ease the pressure,” he says.
Even so, “there are considerable uncertainties regarding the growth outlook,” the Johannesburg-based analyst cautions. “We see domestic GDP growth normalizing to 2 percent in 2015, after just 1.5 percent in 2014, and to 2.2 percent in 2016. This implies the growth trajectory remains substantially slower than the average 4 percent recorded in the decade to 2008.”
Ongoing infrastructure bottlenecks, particularly in electricity, and tighter macro policies — both fiscal and monetary — are likely to constrain economic growth over the forecast horizon to a pace that is below the nation’s GDP growth potential of roughly 2.5 percent per year, Morris adds.
That doesn’t mean there aren’t opportunities to make money. The Fed and the South African Reserve Bank are likely to enter a tightening cycle in the second half, he says, and in such an environment, defensive sectors have tended to outperform cyclical and rate-sensitive stocks.
“We recommend buying quality stocks with low earnings beta, and high price beta with attractive relative value,” Morris reports. “We are overweight banks and general financials, transport, tobacco, beverages, food producers, upper-end cash retailers, and technology, media and telecommunications.”
His colleague Uzay affirms the bullish outlook on the nation’s financial names. “We think South African banks are attractive versus regional peers due to high earnings visibility and stable returns,” says the London-based analyst, citing Barclays Africa Group, Capitec Bank and FirstRand in particular.
Uzay joined BofA Merrill last year from Renaissance Capital, where he was head of Turkey equity research. The post he vacated was filled by Michael Harris, who left BofA Merrill after more than 19 years and is one of the most frequently honored analysts in the history of the Emerging EMEA Research Team survey. Last year Harris led or co-led four crews that finished in first place — in Central & Eastern Europe, Middle East & Africa Equity Strategy; Emerging-Europe Equity Strategy; Middle East & North Africa Equity Strategy (with Stephen Pettyfer); and Turkey Equity Strategy. This year he guides the previously unranked RenCap squad all the way to No. 1 in the latter category.
Slowing economic growth, rising unemployment and plummeting consumer confidence helped make the June parliamentary elections a referendum on the policies of President Recep Tayyip Erdogan. His ruling Justice and Development Party, known as the AKP, suffered a major setback, capturing only 41 percent of the vote. It will either have to join forces with another party to create a coalition, or run the risk that other parties could unite and form a bloc against the AKP.
“To turn the economy around, a stabilization of political sentiment and a continued shift of exports to compensate for lost markets in Iraq and Russia needs to occur,” Harris explains. “On exports, that shift is ongoing as exports to Europe were up 13 percent in euro terms in the first quarter and exports to the U.S. were up 14 percent in dollar terms.”
Unlike the situation for many other emerging economies, the London-based team leader notes, Turkey’s need for reforms is less to enable it to grow than to foster sustainable expansion. “Political calm should be enough to restart the cycle, which is otherwise helped enormously by lower oil prices,” he says. “But if we get continued uncertainty, then the economy and Turkish assets will likely continue to struggle.”
One issue on which this group breaks with the consensus regards the impact of a Fed rate increase. “Our message is that Turkey is much less vulnerable than perceived to Fed hikes, but if the dollar appreciates sharply versus the euro and most other currencies, then the dollar debt in the corporate sector — if not quickly swapped to euros — will leave Turkey facing a period of painful adjustment,” he advises. “If we’re right on Turkey not being as exposed as feared, our guess is that the lowly valued banks will be the prime market drivers.”
The 2015 Emerging EMEA Research Team reflects the opinions of more than 500 individuals at 343 institutions that collectively manage an estimated $296 billion in emerging EMEA equities and $145 billion in regional debt. For more information on how this ranking was compiled, click on Methodology.
