2018 Could be Another Knockout Year for Emerging Europe

2018 Could be Another Knockout Year for Emerging Europe

Domestic stocks were a great place to invest in 2017, but hopefully you didn’t overlook opportunities overseas. Emerging markets had a gangbusters year, surging more than 37.5 percent with dividends reinvested, as measured by the MSCI Emerging Markets Index. A combination of rising PMIs—or the purchasing manager’s index I talk so often about—and a steadily declining U.S. dollar helped emerging economies in Asia, Latin America, Europe and elsewhere eke out their best year since 2010.

This was a boon for our Emerging Europe Fund (EUROX), which crushed its benchmark in 2017.

EUROX, which invests in companies domiciled in Central and Eastern Europe (CEE) economies, beat its benchmark, the MSCI EM Europe 10/40 Index, by 2.4 percent and outperformed its main competitor, the T. Rowe Price Emerging Europe Fund (TREMX), by 4.7 percent. Throughout 2017, the fund traded consistently above its 200-day moving averages and ended the year at a three-year high.

I’m optimistic this upswing can be sustained this year, supported by low unemployment, low inflation and record manufacturing growth. The European Central Bank (ECB) has indicated that it will continue its accommodative monetary policy by keeping rates low and expanding its balance sheet some 270 billion euros ($326 billion) through the first three quarters of 2018.

EUROX Outperformed, Thanks Largely to Active Management
 

I can’t stress enough the role active management played here. Using financial indicators such as cash flow return on invested capital (CFROIC) and low debt-to-equity, we managed to outperform the fund’s benchmark and its main competitor.  

Two positive contributors to fund performance last year were an overweight in Turkish stocks and underweight in Russian stocks. When screening for CFROIC, our model pointed to Turkey as having the most attractive companies on a relative basis. Our allocation was well-made, as Turkey far outperformed its CEE peers. The Borsa Istanbul 100 Index ended the year up close to 48 percent in local currency, followed by Poland’s  WIG20, which advanced more than 26 percent.

Again, we underweighted Russia based on our model and after factoring in overall negative investor sentiment, which really began in earnest in 2014 after the country annexed Crimea, inviting international sanctions. The ill will only intensified during and after the 2016 U.S. presidential election, and today, we see Russian stocks, as measured by the MOEX Russia Index, decoupling from Brent crude oil prices.

Historically, Russian stocks have closely tracked Brent prices, which accounted for nearly 50 percent of the federation’s exports in 2016. But it seems now as if a selloff is underway as new details continue to emerge from the investigation into Russia’s meddling in the U.S. election. It appears markets have mostly soured on Vladimir Putin, with the MOEC ending the year down 5.5 percent.

A good illustration of our attentive stock selection in Russian equities was our exit out of Magnit, the country’s largest retailer. We dumped the stock in April after it had lost around 9 percent for the year. By the end of 2017, it had fallen a further 25 percent.

Meanwhile, we remained long Sberbank, the number one holding in EUROX. In the third quarter of 2017, the Russian bank posted a record 224.1 billion rubles (approximately $4 billion) in net profit, an amazing 64 percent increase from the same three-month period in 2016. Sberbank ended the year up more than 46 percent.

A European Manufacturing Boom Could Be Constructive in 2018
 

Besides a weak U.S. dollar, the real catalyst for growth in emerging European markets last year was a reenergized manufacturing sector. Take a look at the PMIs in the CEE area. All of the major economies that EUROX invests in saw manufacturing expand strongly throughout most of 2017—and that includes debt-ridden Greece, which had been a laggard in this area until recently. In December, the Mediterranean country’s manufacturing sector rose the fastest since 2008. (Anything above 50 indicates expansion; anything below, deterioration.)

The PMI, unlike gross domestic product (GDP), is a forward-looking indicator. That all CEE countries are in expansion mode is good news, I believe, for the next six months at least, if not the rest of 2018.

The eurozone as a whole knocked it out of the park in December, posting a 60.6, the highest PMI reading ever in the series’ two-decade history. Germany, Austria, the Netherlands and Ireland all ended the year at record-high levels, while Italy and France had their best showing since 2000.

As I’ve shared with you before, CEE countries have tended to benefit greatly from strong economic growth in its western neighbors, and last year was no exception. The Czech Republic and Hungary were standouts, their manufacturing sectors growing at the fastest rates on improved output, new orders and job creation. Brexit has also been a windfall for the CEE regions, as companies have moved high-quality jobs out of the United Kingdom and into Poland and other central and eastern European Union nations.

Poland Now a “Developed Economy”
 

On a final note, Poland was recently upgraded from the “advanced emerging” category to “developed” by FTSE Russell, effective September of this year. This will place Poland in the same company as, among others, the U.S., U.K., Japan, Germany and Singapore. The country is the first in the CEE region to receive “developed” status, and I believe the news will attract even more inflows from foreign investors.

Among the decisive factors behind the upgrade were the country’s advanced infrastructure, secure trading and a high gross national income (GNI) per capita. The World Bank forecasts its economy in 2018 to grow 3.3 percent, up significantly from 2.7 percent in 2016, on the back of a strong labor market, improved consumption and the child benefit program Family 500+.

Economists aren’t the only ones noticing the improvement. Young Polish expats who had formerly sought work in the U.K. and elsewhere are now returning home in large numbers to participate in the booming economy. Banks and other companies, including JPMorgan Chase and Goldman Sachs, are similarly considering opening branches in Poland and hiring local talent.

This represents quite an about-face for a country that, as recently as 1990, was languishing under communist rule.

Frank Holmes
Global
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Frank Holmes is the CEO and Chief Investment Officer of U.S. Global Investors. Mr. Holmes purchased a controlling interest in U.S. Global Investors in 1989 and became the firm ... Click for full bio

Most Read IRIS Articles of the Week: Feb 19-23

Most Read IRIS Articles of the Week: Feb 19-23

Here’s a look at the Top 11 Most Viewed Articles of the Week on IRIS.xyz, Feb 19-23, 2018


Click the headline to read the full article.  Enjoy!


1. Don’t Get Pinged by the Social Security Earnings Limit


I’d like to introduce you to Peggy. Born in 1956, Peggy will be 62 in 2018. She has worked in retail her whole life, the past twenty-five years spent in management. Peggy divorced from her husband 14 years ago, is still single and has no children. — Dana Anspach

2. We're Back to “Bad News is Good News” and “Good News is Great News”


This week the markets shrugged off last week’s fears and went back to the slow and steady melt up, despite economic news that looked likely to once again rock the boat. — Lenore Elle Hawkins

3. Q1 2018 Factor Views


Themes established in 2017 across a wide range of markets and factors continued to resonate through the fourth quarter. Economic growth was strong and supportive of equity markets across the globe, a range of volatility measures reached all-time lows, and business and consumer sentiment remained elevated. — Yazann Romahi and Garrett Norman

4. A Beneficial Basket of Commodities


Advisors and investors that feel they are hearing more and more about commodities and the corresponding exchange traded products in recent months are right. That is a natural result of dollar weakness and yes, the greenback is floundering again in 2018. — Tom Lydon

5. 3 Trends Shaping the Future of Asset Management


As the industry works to cope with new regulation, wades through an outpouring of new products, learns to satisfy investors’ shifting priorities and manages the active-passive debate, the viability of business units will be questioned, and at times radical measures will be taken. Peter Hopkins

6. 5 Ways Advisors Leave Money on the Table, and What to Do About It


My hope is that this article points out some opportunities for you to make more money and serve your clients at a higher level and that you decide to do something about it. — Bill Bachrach

7. The Market Has Gone Wild! Is It Time to Change Your Investment Strategy?


Whether the market is flying high or taunting your emotions with new lows and some bumpy volatility, here are four things every investor should keep in mind ... — Lauren Klein

8. How to Deepen Client Relations and Capture New Business Using Engaging Content


Why financial advisors NEED to understand much more clearly the power of good digital market. With tools like AdvisorStream, it’s easier than ever to get the content you need to drive leads and referrals today! — Kirk Lowe and Matt Halloran

9. Three Ways The Most Successful Gain Big Attention


How do some firms and ideas go from nowhere to everywhere in a few short months? All of a sudden a restaurant becomes popular, a gas station gains a cult following, or a Broadway show becomes too popular to get a ticket for years. — Maribeth Kuzmeski

10. Who Are the Hottest FinTech Firms and Influencers Around the World?


"Worldwide, $27.4 billion poured into fintech startups in 2017, Accenture reports, up 18% from 2016. With so much in play, it’s not surprising that 22 companies are new on this, the third edition of our list."  — Chris Skinner

11. The New Stock Market Normal Is Not What You Think!


Many sensational headlines have been written the past few weeks about market declines, but two things have increased for sure: the viewership and the ad revenues of financial media organizations — Preston McSwain​​​​​​​

Douglas Heikkinen
Perspective
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IRIS Co-Founder and Producer of Perspective—a personal look at the industry, and notables who share what they’ve learned, regretted, won, lost and what continues ... Click for full bio