By Peter Elam Hakansson, Chairman and Head of Public Equity investment team, East Capital.*
The first month of the year turned out to be a very difficult one for emerging markets, with a fear of tapering by the US Federal reserve and a slowdown of the Chinese economy leading to a sharp sell-off of emerging market (EM) currencies and equities.
The most fragile emerging economies – the ones with large macro imbalances that are dependent on external financing – experienced the biggest correction, which in turn spilled over to other, more healthy, economies. We argue that the EM scare is exaggerated and far too broad, but at the same time not entirely surprising given the poor sentiment towards emerging markets during the second half of last year.
Almost everyone agrees that the two main reasons behind the EM scare in January were related to the start of tapering and fears of a slowdown in the Chinese economy. Even though it is true that tapering started in January (the FED reduced its monthly asset purchases from USD 85bn to 75bn) it was hardly a surprise as the announcement was made in December and markets started to price it in from May last year. One of the expected consequences of tapering was that US interest rates would increase, much like they did in the second half of 2013, when the 10-year yield surged from 1.66% in early May to 3% by the end of the year. But it did not continue to rise in January. Quite the contrary, it fell to 2.66%, but emerging market assets nevertheless corrected which led us to argue that fears of soaring inflation were greatly exaggerated.
The concerns about a Chinese slowdown are similarly overstated. It is true that PMI dropped below the 50 level that is considered a crucial indicator and that there are important structural challenges for the economy. But, it is also true that everyone that has been betting on a hard landing for the Chinese economy has been spectacularly wrong.
Another problem with the January sell-off was that it was largely indiscriminate. We are fundamentalists who believe that underlying economic and market fundamentals matter. This was not the case in January though as most EM currencies and equities corrected regardless of fundamentals. There are important differences across the EM space or even within different EM regions. We, for instance, consider Russia one of the most fundamentally attractive emerging markets at the moment, while the opposite is true for Turkey. In Asia, we find China and Korea attractive, while India and Indonesia look more fragile.
Most of the major stock markets in Eastern Europe and emerging Asia fell on the back of the deteriorating sentiment. Turkey was worst hit, dropping 12.8% after the TRY depreciated sharply against the USD and the EUR. The currency situation stabilised somewhat after its Central Bank hiked the rates aggressively. The Russian, Polish, South Korean and Chinese markets, which have more solid fundamentals, were also affected negatively and dropped between 4-8%. A number of other markets – such as Hungary, Malaysia, Hong Kong, Singapore and Romania – got away with smaller corrections, but the real place to hide was in the frontier. The small markets in Vietnam, Bulgaria, Lithuania and Slovenia outperformed massively by gaining 13.6%, 11.3%, 7.6% and 6.8% respectively. A number of other markets in the Baltics and Balkans also closed the month in positive territory, but Indonesia was perhaps the biggest surprise as it gained 5.8% even though it is considered one of the five fragile markets.
The correction was not entirely indiscriminate and has also opened up opportunities. Austrian banking giant Raiffeisen International, which has operations throughout Eastern Europe, gained 18.8% and Slovenian insurer Zavarovalnica Triglav rallied 17.7%. We increased both stocks in our portfolio. In Asia, we increased our position in Great Wall Motor in China and added Airports of Thailand to the portfolio after both stocks fell sharply.
* East Capital Group is a leading emerging and frontier market asset manager specialising in Eastern Europe and Emerging Asia. The group, which is an independent partnership set up in 1997, manages approximately EUR 3.5 billion in public and private equity funds as well as separate accounts