Bank of America Merrill Lynch seizes first place on the Emerging Europe, Middle East & Africa Research Team, Institutional Investor’s exclusive annual ranking of the region’s best sell-side analysts, for a fourth straight year. The firm earns a spot in all but one of the survey’s 21 sectors, missing out only for coverage of Central & Eastern Europe (CE3).
J.P. Morgan’s team total rises by one, to 14, and that’s enough to move the bank up a notch to No. 2. Citi leaps three levels to third place after boosting its total from eight to 13. Deutsche Bank, last year’s No. 2 firm, tumbles to fourth place after losing four spots, leaving it with 11. UBS repeats at No. 5; its total rises by one, to ten. Click on the Leaders link in the navigation table at right to see the full results of all ranked firms.
The order changes when a weighting of 4 is applied to each first-place position, 3 to each second-place spot and so on. BofA Merrill is still victorious — and by a very hefty margin — with a weighted score of 67. Deutsche claims the second tier, with a score of 24; while Citi, J.P. Morgan and UBS tie for third, with 22. Click on Weighting the Results in the navigation table to see how each firm fares when this formula is applied.
The 2016 Emerging EMEA Research Team reflects the opinions of more than 630 individuals at 375 institutions that collectively manage an estimated $320 billion in regional equities and $157 billion in emerging EMEA debt.
The past year has been tumultuous for asset managers that invest in these markets, with stocks tumbling more than 19 percent, in dollar terms, in the 12 months through May. Yet that tide may be turning. Year-to-date they’re up 6.5 percent, outpacing the S&P 500 by 3.9 percentage points.
“The EEMEA region has been primarily affected by the collapse and recent rebound in oil prices, the strong dollar and higher U.S. interest rates, a slowdown in China and continued geopolitical turmoil,” explains Francisco Blanch, who with Michael Widmer leads BofA Merrill to No. 1 in Commodities.
In other words, don’t blame the region itself for its volatility — at least not entirely. “The main influences on EEMEA markets over the past few months have been external rather than internal,” confirms John Lomax, head of global emerging-markets equity strategy at HSBC. He and Raj Sinha oversee the team that rises from second place to first for coverage of the Middle East & North Africa. (Lomax also manages crews that earn runner-up spots for reporting on South Africa, with Nicholas Webster, and Turkey, with Bülent Yurdagül). “In particular, the performance of regional equity markets has been heavily conditioned by perceptions of U.S. and Chinese growth and policy.”
Until mid-February or thereabouts, he adds, China was regarded as growing weaker while the U.S. seemed to be gaining on the expectation that the U.S. Federal Reserve would continue to raise interest rates. “This was interpreted as being negative for emerging-markets equities, because most EM countries and sectors are tied into the Chinese cycle,” Lomax says.
Market perception changed, however, after the Fed announced that it might slow the pace of rate hikes, the dollar depreciated and Chinese policy makers shifted gears. “This environment was a lot more favorable for emerging markets — particularly those exposed to commodities, which dominate the EEMEA space,” the London-based crew captain observes.
Commodities prices have been volatile, too. Their prospects going forward depend largely on which products you’re talking about.
“The meltdown in oil and commodities prices has had a negative effect across all asset classes in EEMEA, negatively impacting equity and bond values, as well as foreign exchange and interest rate levels for most key economies,” contends Blanch, head of global commodities and derivatives research at BofA Merrill in New York. Yet the strategist notes that the differences between energy commodities and metals, for example, are fundamental. “The decline in metals prices is a multiyear phenomenon caused by excess investment and sagging Chinese demand, while the drop in energy prices is an 18-month trend resulting from a major technological change — U.S. shale — and exacerbated by a dramatic turnaround in Saudi oil supply policy to increase market share.”
Accordingly, in mid-February he and his teammates began advising clients to “position for higher oil prices, as we expected the forces that took the market down, including a warm winter, to go into reverse,” Blanch says. They now believe the price of Brent crude, which stood at $49 a barrel in late May, will surpass $70 in the next few years.
The more cyclical commodities — those tied to the Chinese economy — also show promise. “The U-turn in China’s economic policy, including fiscal and monetary stimulus, has contributed to a rebound of growth in the country, which in turn supported prices,” Widmer reports. “Of course, there are a lot of questions about the sustainability of the recovery, but for now it’s apparent that China is doing much less bad.”
The London-based director of global metals research is “cautiously optimistic that the worst is over for most cyclical commodities, with output growth slowing as producers are forced by markets to repair their balance sheets. Further cyclical strength in global growth would also help.”
On the other hand, industrial metals and mining prices remain soft. The analysts project “muted iron-ore, copper and thermal-coal prices ahead,” Blanch says. Regarding the latter product, in particular, he adds, “China’s consumption is set to continue falling just as India’s domestic supplies are poised to keep growing at a fast pace.”
Precious metals are another story. “With gold the most significant driver has been a switch at the Fed from being hawkish in a disinflationary environment to being dovish in a reflationary environment,” says Widmer. “This has pushed real rates lower, which in turn attracted gold buyers.” He foresees rising gold prices for the next few years as government bonds start to deliver negative yields, although with one caveat: “Additional Fed rate hikes could temporarily halt gold’s upward drift,” he advises.
The BofA Merrill team is currently overweighting both energy and precious metals, and they are cautious on industrial metals and mined commodities.
Geopolitical tensions have also preyed on EEMEA portfolios. The possibility that later this month Great Britain might withdraw from the European Union, for example, has received much nervous speculation and media attention. “A Brexit could become another serious test for EEMEA, but for now it is premature to discuss the particular consequences for the region,” says Alexander Kudrin of Sberbank CIB, who leads the team that outperforms all others on coverage of Russia.
That country has had its own issues, but analysts insist its markets offer opportunities, in part on the “improvement in domestic consumption,” according to BofA Merrill’s Simon Greenwell, who in January replaced Anthony Bor as co-head of global emerging-markets equity research. (Bor left to become a partner at London-based h2glenfern, an independent research and advisory firm.)
For example, leading lender Sberbank of Russia is “well positioned for a potential improvement in macro,” Greenwell maintains, as is Magnit, a discount retail chain with “a consistent track record of organic space addition in recent years, the industry’s most ambitious expansion program and a focus on the Russian regions where competition remains relatively low.”
A similar mix of stresses and select openings can be found in Central & Eastern Europe, colloquially known as the CE3. Wood & Co., an investment bank based in Prague, scores a rare first-place debut on the roster with a team directed by Alexandros Boulougouris and Marta Jezewska-Wasilewska.
The analysts are “moderately positive” on the region, Boulougouris says, citing its robust real gross domestic product growth outlook, undemanding valuations and high dividend yields. They have been urging clients to “either stay with the names that are geared to the superior growth of GDP, or invest in dividend plays with lower beta that are attractive in such a low-interest-rate environment,” he adds.
Among the negatives, Jezewska-Wasilewska notes, are the situation in Poland after October’s parliamentary elections, an impasse between the Greek government and its creditors and political tensions in Russia and Turkey.
Special care should be taken with the region’s banking sector — especially in Poland, these researchers advise. Polish lenders have been saddled with some $42 billion worth of mortgages that were issued before 2008 and denominated in foreign currencies, primarily Swiss francs to take advantage of lower Swiss interest rates at that time. In January 2015 the Swiss National Bank ended its three-year-old cap on the franc-euro exchange rate, effectively raising those loan holders’ repayment costs. A year later, Polish president Andrzej Duda proposed forcing banks to convert such loans to zloty at historical exchange rates, leaving the banks to eat the losses. The matter remains unresolved.
The Wood & Co. squad is more upbeat on the prospects of the Czech Republic’s Komercní banka, citing the nation’s strong GDP growth and the institution’s stable dividend flow. Also recommended: Austria’s Erste Group Bank, “which has a business model grounded also in the Czech Republic,” Boulougouris says.
The situation in South Africa is far more challenging. Late last week Standard & Poor’s opted not to downgrade the country’s credit rating to junk status but maintained its negative outlook, citing “low GDP growth, volatile sources of financing, structural current account deficits, and sizable general government debt,” among other concerns.
BofA Merrill tops this roster for the fifth time in six years. Crew chief John Morris now shares oversight with Ilze Roux, who predicts a treacherous year ahead that will nevertheless reward a small number of lucky — and careful — investors. Consumer and business sentiments are low, and there are “currency and growth challenges in the region,” she reports, but “valuations on a select few stocks with strong competitive advantages are simply too cheap to resist.”
Recommended names include Barloworld, an auto-fleet rental and logistics conglomerate — the analysts’ 12-month price target of 8,200 rand represents nearly 14 percent upside potential from the stock’s late-May level — and packaging manufacturer Nampak, which the analysts believe could rise as high as 2,800 rand in the year ahead. In late May those shares were trading at 2,060 rand.
Just as emerging EMEA markets are showing signs of promise after months of disappointment, so may be the region’s less developed economies. “It has felt like the worst of all worlds — high beta in down markets and low beta in rallies,” affirms Andrew Howell, who leads the Citi group to the top spot in Frontier Markets. Plunging average daily volumes have been an additional “disincentive to investors who might look to these markets to put on a reflation trade,” he adds.
However, the New York–based analyst notes, “there are signs that liquidity is returning to frontier markets, especially in such oil-exporting countries as Bahrain, Kuwait and other members of the Gulf Cooperation Council. “Valuations have come down significantly, earnings are holding up, economic momentum is reaccelerating in many markets, and fund flows have turned positive again after 17 consecutive months of outflows,” Howell says.
Stocks that he and his associates are recommending include two United Arab Emirates–based companies: DP World, which runs cargo-handling marine terminals, and Emaar Properties, a real estate developer; Egypt’s Commercial International Bank; Estonia’s Tallink Grupp, a ferry operator; Georgia Healthcare Group, a provider of medical care and insurance; Romanian state-owned electricity supplier Electrica; and Ukrainian agribusiness operator Kernel Holding.
