By Charlie Robertson
24 JUNE 2016-Where I live had the 3rd highest level of support for REMAIN in the referendum – which invalidated me as a useful commentator on Brexit risk impact on MSCI EEMEA and MSCI Frontier. Here we try to make amends.
GLOBAL
There is a pan-Developed Market aspect to this anti-establishment vote – which is likely to raise market concern that Donald Trump could become president of the US in November 2016, or Marie Le Pen may do well in the French presidential election in 2017, or the hard-left may do well in Spain’s forthcoming parliamentary elections, etc. We still imagine that political trends support a shift against the richest in society (London voted to Remain), and in favour of Keynesian spending.
The greatest uncertainty surrounds the future of the EU. Opposition parties in France and the Netherlands are calling for referenda in their countries on the EU. If either of them were to be given referenda (unlikely) and voted to leave (presumably unlikely), it would trigger Euro break-up.
What the Brexit vote will do is add to uncertainty among corporates in Europe – who will be less likely to invest until there is clarity about Europe’s future. The global economy is already weak. There is a chance this ends up tipping the US economy into recession, and that it becomes the catalyst that leads to a 50% fall in the S&P500 over 15-18 months – a risk-scenario we flagged in 2015 and reiterated in January 2016 (neither time did I see Brexit as likely).
So the base case should be a weaker global economy, which will be more negative for oil, and means central banks globally keep rates lower for longer. This is negative for banks. A prolonged market crash remains only a risk case scenario – in which gold today looks the safest play.
For investors – unsurprisingly Emerging Europe looks most vulnerable to uncertainty. Asia or Latin America (which is rejecting populists) look better. The same applies for Frontier investors.
EEMEA
Greece is “the most obvious short in EM” according to our head of research Mike Harris. The EU is going to find it very difficult to advance political integration given the rise of populism. So how will it resolve the Greek debt problem? The Greek market has fallen the most this morning.
Central Europe – usually our safe haven has performed worst this morning for obvious reasons – along with manufacturing Korea which is impacted by moves in the JPY. Each have remained outside the Euro. The Czech Republic has historically been the most Eurosceptic country of the three until the current president was elected.
Czech Republic – is a market dominated by banks so suffers from the likelihood of low interest rates for longer.
Poland – is the most liquid CE3 market.
Hungary and Poland – are both run by parties that are anti-immigration, and have been clashing with the EU. The EU will have its hands full. It is less likely to act as a successful restraint on populist gestures from these two governments. This is market unfriendly.
Turkey still sails close to the wind – and interest rate cuts have reduced what little insurance premium there was for investors (the new CBT governor is untested in a crisis). It suffers from weaker exports to the EU but gains from loose ECB/global policy.
Russia – loses from a weaker global economy in terms of the oil price, but 1) has an idiosyncratic recovery story after two awful years of 2014-15 and 2) might see EU sanctions ease as the UK was united with Germany in sanctions against Russia.
In a negatively hit Emerging Europe, we see Russia faring relatively best.
Elsewhere in MSCI EEMEA – SA is most vulnerable via the currency which remains the risk proxy for this time zone. SA’s market is also exposed via global companies like the brewer SAB, as well as exports (eg SA makes the BMWs that are sold in the the UK).
Egypt, UAE and Qatar are closed today. Egypt has a particularly closed economy which helps – but will not be a safe haven play for investors due to currency problems. The UAE is a global growth proxy. Qatar looks safest despite its sovereign wealth exposure to the UK.
FRONTIER
Clearly uncertainty hits Emerging Europe most. The most liquid market is Romania (3.55% of the index) which has fallen 5% this morning – more than any other market. It is a market we have liked a lot, but like the Czech Republic is bank dominated. Estonia, Lithuania, Slovenia, Croatia, Serbia, Bulgaria (expected to be out of the index by November) make up 4.36% of the index.
Kazakhstan is the second largest decline in Frontier – down 4% and this looks overdone. This may be because many Kazakh stocks are listed in London via ADRs, and London is down. The currency is cheap and like Russia it is hit by any weakening in oil, but has its own idiosyncratic recovery story. We still think Kazakhstan warrants attention from investors.
We see Argentina as among the best placed to weather a storm, partly because investors are underweight relative to the index, and partly because it has rejected populism in favour of orthodoxy recently.
Vietnam is probably better placed than south Asia – to avoid contagion from a weaker Europe. Vietnam will be exposed to global growth concerns. But South Asia has strong links via remittances (eg to Pakistan which will be worth less from the UK now), trade and financial flows (least important).
Nigeria has an idiosyncratic improving story thanks to electricity, fuel subsidy and now currency reform. We see it as similar to Russia, but expect more investors to enter Nigeria when the currency has found a more liquid level.
The impact on Kenya should be limited. Tourism to Kenya is already weak. More important over 6 months is the risk-on, risk-off trade, and the extent to which Nigeria becomes more attractive since the NGN float.
Morocco is more reliant on Europe, so loses some of the safe haven characteristics we praised earlier this year.
Off index Georgia is banks (not good), listed in London (not good) but otherwise with very limited links to Europe. Bank of Georgia is down 7% in GBP.
CONCLUSION: We think Greece is the biggest short in EM. We believe Russia does best in a declining Emerging Europe. Qatar may do best in EEMEA. We can see why investors will prefer post-populist Latin America or Asia. In the Frontier space, we see post-populist Argentina and Vietnam as doing best. We think Kazakhstan’s fall is not as justified as others. Please see our June 2016 report Fixit which has far more information on every country mentioned here.
Charlie Robertson is Global Chief Economist at Renaissance Capital.
Tel +44 20-3379-7835 (internal x8235). Mobile +44-7747-118-756. CRobertson@rencap.com. Twitter @Rencapman
