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Focal Point The Fifth Element
Renaissance Capital
Investment summary 12 June 2017
The Focal Point
No, we’re not referring to Quintessence, Boron, or the film by Luc Besson, or even the Daniel Salter
album by Bounty Killer. The Fifth Element that we are adding to our top-down asset +44 (207) 005-7824
allocation model for emerging market (EM) equities is the interest rate cycle – DSalter@rencap.com
alongside GDP acceleration, credit acceleration, real effective exchange rate (REER) Charles Robertson
currency valuation and scope for credit rating upgrades. Vikram Lopez shows that interest +44 (207) 005-7835
rate cuts tend to coincide with periods of EM country outperformance (for more on this, CRobertson@rencap.com
see p. 77).
Vikram Lopez
+44 (207) 005-7974
EM equities are benefitting from global tailwinds which could continue through VLopez@rencap.com
year-end – although following MSCI EM’s 17% US dollar return over the first five months
Yvonne Mhango
of the year, and with several global lead indicators having rolled over (albeit from strong +27 (11) 750-1488
levels), we would expect the pace of returns to slow and to be interspersed with YMhango@rencap.com
occasional profit taking. The eight-year bull market in developed markets (DM) has been
Oleg Kouzmin
a pain trade for a sceptical investor base, and we see EM’s 18-month old bull market as +7 (495)258-7770 x4506
having similar characteristics. OKouzim@rencap.com
Research analysts
Despite strong performance YtD, EM equities have yet to fully close their US
election-related underperformance vs DM. Fears of overt protectionism, so-called
‘Trumpflation’ (and the associated strong dollar, higher bond yields and rapid Fed hikes)
have subsided. With US stocks appearing priced for perfection (on 18x 12M FWD P/E vs
a 10-year average of 14x) the upwards pull on EM valuations (with EM on 12x vs a 10-
year average of 11x) is there, but so is a potential external correction source. Frontier is
cheaper still (on 11x) but is failing to attract the ETF flows that have buoyed EM (which
has 30x better liquidity). Meanwhile, the EMBI global debt spread of 322 points has
tightened significantly from November’s 407 peak, but is still not as tight as the 240-point
post global financial crisis (GFC) low. And EM’s 12.3x 12M FWD P/E multiple has yet to
breach the post-2010 high of 12.8x (in April 2015). Consensus now expects the strongest
EPS growth in EM since 2010, of 28%.
The IMF’s recently published World Economic Outlook points to 2017 being the
second year of relative economic acceleration for EMs vs DMs, a trend which the IMF
believes is likely to continue for several years to come. Global growth in 2017 is also likely to
be much more synchronised with all of the world’s top 40 economies expected to grow this
year, for the first time since 2007. World trade growth is currently 1.4% YoY (on a three-
month moving average basis) and though off recent highs appears to have broken out of its
sluggish 0.5% rate of 2011-2016. The global manufacturing PMI of 52.6 for May is well into
expansion territory and EM current account deficits have been reduced significantly from
2012-2013 peaks, suggesting greater resilience to gradually tighter global monetary policy.
Meanwhile, the market’s re-assessment of the Trump administration’s ability to
streamline passing legislation and willingness to engage in damaging trade wars
has put an end to the dollar rally, put a lid on US inflation expectations and with it US
bond yields, helping global markets (so far) to rally. Futures suggest just one-to-two
further Fed hikes by year-end, while ECB President Mario Draghi is “firmly convinced that
an extraordinary amount of monetary policy support is still necessary” (and Brexit argues
for a focus on growth by EU policymakers). The IMF’s expected global growth of 3.5-3.7%
in 2017-2019, includes a gradual acceleration, but not to the kind of pace which would
suggest the kind of commodity/inflation spike that we saw in 2007-2008 as the world “ran
out” of oil and other commodities after annual average growth exceeded 5% pa over
2004-2007. Energy and materials make up just 14% of MSCI EM (IT and telecoms are
twice as important) but 24% of MSCI EMEA. EM can manage gradual Fed hikes: between
2004 and 2006 the Fed hiked rates from 1% to 5.25% in a period of major
outperformance for EM equities. Range-bound oil is a positive for reform in energy
exporters (and good for global inflation). And, although the US expansion is now much
longer in duration than the average post 1945, cumulative real GDP growth in the current
expansion is still below the average (17% vs 25%): the window is thus still open for EM,
2Renaissance Capital
12 June 2017
The Focal Point
we believe, and we may yet be a year or so away from the next major US equity sell-off.
Our work shows that it is when US CPI hits 3% (currently 2.2%) that we believe investors
should prepare to take money off the table in EM.
After a long period of EM underperformance (as EM economies slowed relative to
DM), portfolio flows are returning. According to the Institute of International Finance,
cross-border flows in to EM bonds and equities exceeded $20bn for the third consecutive
month in April (a record since 2014). EPFR data show that EM equity funds have seen
inflows of $28bn in 2017 YtD, with EM debt funds receiving inflows of $33bn. But the recent
inflow comes after $155bn of outflows from EM equity funds over 2013-2016, and to date,
just $37bn has returned (less than one quarter of the outflow). Debt funds have seen 85% of
their 2013-2016 outflows return, suggesting EM debt flows may be more mature.
In conclusion, the EM drivers are a combination of a cyclical upturn globally, with
more synchronised global growth, and benign inflation giving central banks wiggle
room; improved EM growth relative to DM, as well as an earnings pick-up and returning
flows. To be sure, EMs are not without their challenges. Considering the BRICS, Brazil
and Russia are still struggling with low growth, Brazil has fallen in to a new political crisis
and hopes for an easing of sanctions on Russia have faded; South Africa’s lacklustre
economy fell into its second recession in eight years in 1Q17, and political challenges
remain unresolved; while China’s attempts to slow the housing market and tackle the
shadow banking system risk slower growth and increased volatility. Meanwhile, Indian
bank lending has now dropped to the slowest pace in 63 years. That said, both Brazil and
Russia are exiting multi-year recessions, China is unlikely to want (and has the tools to
prevent) growth being hit too much ahead of October’s 19th National Communist Party
Congress, and South Africa’s political issues could yet see more market-friendly ANC
leadership (or failing that, the 2019 polls could lead to change). The IMF expects India’s
growth to exceed China’s for the third year running in 2017 (and to accelerate for the next
five years).
We look for exposure to seven main themes in EMEA and FM:
Economic recovery stories in 2017 and 2018: For 2017, that suggests to us
Russia, Greece, Hungary, Qatar and Poland within EMEA. Argentina,
Morocco, Nigeria (at least according to IMF data), Kazakhstan, Pakistan and
Vietnam in Frontier. For 2018 though, the list changes somewhat, with UAE,
Egypt, Turkey, South Africa and Greece leading the pack in EM, and Kuwait,
Oman, Nigeria, Kazakhstan, Saudi Arabia and Kenya in Frontier.
Cheap currencies: In EMEA, Egypt remains one of the cheapest currencies in
our 20-year REER model (with Colombia and Mexico also looking cheap).
South Africa (5% cheap), Greece (2.2%) and Turkey (3%) are just slightly
cheap and some would argue ought to be cheap given political issues; while in
Frontier, Tunisia and Kazakhstan have cheap currencies, as apparently does
Argentina using official CPI data (though using an alternate CPI history may
make it slightly expensive), with Serbia (8%) and Senegal (4%) on the cheap
side of fair value. Morocco is close to fair value.
Potential upgrade stories: We see the Czech Republic and Greece, as
potential credit upgrade stories in 2017, with Egypt also a potential upgrade
story (but only towards year-end) in EMEA, Argentina in Frontier.
Bank lending acceleration: We see Hungary, Russia, Turkey and Greece well
placed within EMEA, and Kazakhstan, Romania and Pakistan within Frontier.
3Renaissance Capital
12 June 2017
The Focal Point
Scope for rate cuts: With Russia, Turkey (as inflation eases in 2H) and Egypt
(perhaps by year-end) as candidates to cut rates in EMEA, and Kazakhstan,
Argentina and Kenya in Frontier.
Exposure to the EU rebound: Poland, Czech, Hungary and Turkey (and
perhaps Greece) we see as particular beneficiaries of an improving Eurozone
economy. Romania, Morocco and the smaller EU markets in Frontier.
Idiosyncratic stories: e.g. MSCI inclusion – on the positive side, Argentina
(which we see as a strong candidate for inclusion in MSCI EM - we should find
out the results of MSCI’s review on 20 June); and less positively Pakistan
(which has already transitioned from MSCI FM to MSCI EM at end-May, and
where we see Frontier funds as likely to be net sellers, with EM investors taking
their time to learn a small, volatile, new market, despite the striking discount to
neighbouring India: 11.0x vs 17.3x for India on a 12M FWD P/E basis). Nigeria,
we believe warrants more attention as a more freely traded FX market appears
to be opening up for international investors who are generally very underweight.
Historically, investors main justification for investing in EM equities has been faster
GDP growth for EM than DM feeding in to better growth of EPS. EM failed to deliver this
over 2011-2015 as EM GDP growth relative to DM decelerated following the reversal of post
GFC fiscal and monetary stimulus in EM as inflation picked up. Corporates found
themselves with excess capacity (whether industrial or commodity) and weak pricing, while
a strong dollar depressed EM FX and raised costs of debt (particularly FX denominated).
May 2010-January 2016 saw EM equities underperform DM by 50%. 2016 saw EM
economies start to reaccelerate vs DM and the start of the EM earnings rebound, with 18%
growth in EM EPS the highest since 2010, and consensus expects an acceleration to 28%
in 2017, driven by accelerating EM GDP, the rebound in energy and metals prices, as well
as stronger EM currencies (the headline number is distorted by the EM FX rebound and a
number of large EM corporates moving from headline loss to profit).
How does FM stack up vs EM?
1. Better growth in EM, but better recovery in FM: The IMF forecasts MSCI
EM countries to grow real GDP by 4.7% in 2017– well ahead of DM’s 1.6%
for 2017 and ahead of Frontier’s 3.3% (which is brought down by sluggish
growth in Argentina, Kuwait and Nigeria, between them, 46% of MSCI FM).
EM Asia is expected to be the fastest growing region within EM, followed by
EM EMEA. However, Frontier does have a better growth acceleration than
either EM or DM for both 2017 and 2018.
2. Earnings: EM has the advantage in terms of EPS growth, with 2017E EPS
to grow by 16% vs 14% in Frontier and 2018E EPS growing by 12% vs 4%
(however, this should be taken with a note of caution as many frontier
stocks lack analyst forecasts).
3. Valuations: EM is trading on a 12M FWD P/E of 12.3x, above its post-GFC
average of 11.2x. Frontier is currently on a 12M FWD P/E of 11.1x, also
above its average of 9.4x. However, Frontier’s 10% discount to EM is still
below its average of 5%, while EM’s discount to DM stands at 26% vs an
average of 21%. On a P/B basis, FM and EM are on similar multiples (1.7x)
and are somewhat below DM (2.3x); however, Frontier boasts a higher RoE
than EM (11.3% vs 10.4%). EM’s RoE has improved in recent months, but
has a long way to match previous high points in 2011. Focusing on
dividends, Russia boasts the highest 12M forward dividend yields in EM at
6.1%. In Frontier, Mauritius, Oman and Kuwait offer the best dividend yields,
4Renaissance Capital
12 June 2017
The Focal Point
at 9.5%, 7.3% and 6.2%, respectively. In aggregate, Frontier offers higher
dividend yields than EM, at 4% vs 2.7%. In aggregate, Frontier offers a
higher dividend yield than EM, at 4% vs 2.7%. Taken together, the
valuations argument is more favourable for Frontier than for EM, with
Frontier’s higher yields potentially attractive in an income-starved
environment, though investors have to be prepared for much lower liquidity
(see below)
4. Liquidity: Liquidity is still a challenge in Frontier, and may yet become
worse should Argentina follow Pakistan into MSCI EM (we will find out the
results of MSCI’s review of Argentina on 20 June). Liquidity in Frontier has
fallen a long way from its peak in 2008, trading $490mn a day (for the
current countries in MSCI Frontier, including Pakistan’s c. $100mn) vs a
peak of $1bn a day in early 2008 (for the same set of countries). By
contrast, EM liquidity has been picking up, with turnover currently $16.3bn
per day, up from $13bn per day in March 2016, roughly 30x that of Frontier.
5. Flows: Since the start of the year, EM has seen a little under $28bn in inflows,
while Frontier has lagged, seeing outflows of $0.4bn (to end-April 2017). This
is partly due to inflows going overwhelmingly to passive funds ($21bn, or 75%
of the total inflow), an area that is still undeveloped in Frontier; however,
higher frequency data (covering 50% of Frontier AuM) has shown flows
turning more positive ($0.1 in inflows over the past four weeks).
Do EM equities need to consolidate? We doubt that the pace of the EM rally can be
sustained without any correction. MSCI EM is up 18% YtD in dollar terms, with a
maximum pullback of just 3%). A lot of short-term good news has been priced in: global
PMIs have already seen much of their recovery, the reflation trade is fairly mature, net
speculative positions are now long euro vs dollar and the market has, in our opinion,
already become much more relaxed about potential threats to the EM trade from US
politics. Equity volatility is low, despite political noise in the US (and UK) and the
diplomatic spat in the Gulf Cooperation Council (GCC). May came and went without the
traditional equity bull market correction. Momentum remains good, with strong inflows in
to EM funds – in our view, the risk probably comes on the (geo-)politics side – does US
policy jeopardise the EM positive backdrop of a weak dollar, low rates and gradual global
recovery; or does US policymaking disorder start to impact growth; or do EM political
problems flare up once more in Brazil, South Africa or elsewhere; and over the longer
term, to what extent is the tide turning against globalisation: US protectionism could yet
reappear on the agenda, particularly if the US economy falters. For China, which is
tightening lending rules and cracking down on the shadow financial sector, the run-up of
debt is an obvious medium-term concern, but with China still a net international creditor,
the financial system is domestically funded and the government still has relatively little
debt. The risk is that greater regulations on the shadow financial sector ends up tightening
financial conditions more than expected, leading to slower growth/liquidation of financial
assets. The priorities emerging from October’s congress will be key. EU elections
(Netherlands, France, Austria) have so far proven the doomsayers wrong – Germany
goes to the polls, and perhaps Italy, in September. And lastly, there are some signs that
short-run data may be rolling over: trade, ECSI, US ISM, global and EM PMIs are all off
their peaks.
5Renaissance Capital
12 June 2017
The Focal Point
Country allocation
Themes we like in EMEA include exposure to a recovering Eurozone economy
(Central Europe) and interest rate cuts (Russia and later in the year, Turkey). Our
conviction on Russia remains low, however, given the lack of momentum in oil, the
slow pace of reform pre-elections and continued geopolitical issues. South Africa,
we see as constrained by politics, and in Egypt we believe the market needs more
visibility on a potential 2018 rebound and/or rate cuts to perform; Greece has the
potential to perform well, but a longer-term debt deal may need September’s
German elections to be out of the way. We are underweight UAE and Qatar as low
beta emerging markets, and given the recent increase in regional tensions.
We are overweight Poland and Hungary, Turkey and Russia. Russia with low
conviction: we do like the domestic economy rebound and rate cuts (and expect the
consumer to turn positive in 2Q17), but see scope for an acceleration in reforms pre-
election as limited, and assume oil to be rangebound around $50-55/bl. With progress on
sanctions relief looking unlikely, marginal investors may be inclined to stay on the
sidelines. We retain our overweight on Central Europe, given improving Eurozone PMI
numbers and the rebound in the euro. Turkey we see as a tactical recovery story based
on a rebounding economy after a weak 2H16, with strong credit growth likely to lead to a
strong economic rebound and potential EPS upgrades particularly for the banks. Our twin
concerns remain over the debt cycle and political longevity.
We are neutral South Africa, Greece, Egypt and Czech Republic. In South Africa, we
see political risks and structural issues undermining the rebound in the economy, and the
rand vulnerable in 2H. Greece has the potential to be a strong recovery story (with banks
on just 0.3x BV) but where a resolution of long-term debt issues might be delayed until
after September’s German elections. The Czech Republic, within CE3, we see as a low
beta emerging market, with a lack of interesting listed stocks. Egypt we bring back to
neutral after a 31% dollar return for the EGX30 index (more representative than MSCI
Egypt) since the November lows. We still think the currency is very cheap, but the market
needs visibility on the expected 2018 rebound as well as rate cuts, which might be a story
closer to year-end.
We are underweight Qatar and UAE. Both are low beta vs EM. UAE we see as a 2018
recovery story: real estate prices continuing to fall in 2017. Regional tensions with Qatar
may keep the market there under pressure.
Within Frontier, our main changes are to become more positive (or less negative)
on Nigeria, which we upgrade to neutral. And to recommend trimming Pakistan
back to neutral for Frontier managers (where the country has become off index)
after strong performance.
We are overweight Kazakhstan, Bangladesh, Argentina and Vietnam. In
Kazakhstan, we like the economic recovery and valuations, and see scope for positive
surprises given low expectations on reform. In Bangladesh, we like the high levels of
investment resulting in sustainable strong growth, and we see the country as a potential
beneficiary of flows out of Pakistan from Frontier funds. In Argentina we continue to like
the reform story, the economy should rebound this year, and progress on inflation could
allow the central bank to reverse the recent rate hike. Argentina is a potential candidate to
return to MSCI EM – we should find out on 20 June. Valuations are no longer cheap,
however. In Vietnam we expect the government to privatise assets to help the budget,
which in turn should help transparency; a return to a strong current account surplus eases
currency worries, and we see unsatisfied demand from FM investors given foreign
ownership limits.
6Renaissance Capital
12 June 2017
The Focal Point
We are neutral Pakistan, Nigeria, Kenya, Morocco and Romania. In Pakistan, we see
Frontier funds as likely net sellers after the country’s end-May transition from MSCI Frontier
to MSCI EM; and whilst we like the growth story and increased infrastructure investment,
political noise is likely to increase in the run up to the summer 2018 elections, and we see
the currency as overvalued (contributing to poor export performance). Nigeria we think
warrants attention again. Yes, there are still challenges on the reform and budget side, and
investors are still assessing the new Investors’ & Exporters’ (I&E) window which is not fully
transparent. The first few weeks have seen a daily average of c. $100mn of trades reported.
For equity investors who can get in to Nigeria at close to NGN400/$ we believe it is worth
considering starting to close underweights (or finding a way to buy local bonds). Kenya we
like long term as one of the more entrepreneurial economies in Sub-Saharan Africa (SSA),
but the market has run hard, as investors price in a likely peaceful August election,
potentially followed by an easing of interest rate caps on the banks. Morocco, we like the
growth rebound and exposure to the Eurozone recovery, but valuations are full and we see
the country’s safe-haven status for investors eroded by the opening up of FX markets in
Egypt and Nigeria. Romania, the growth story remains strong, and we like the exposure to
a recovering Eurozone, however the quality of growth is declining as the current account
widens, the budget deficit expands and inflation picks up.
We are underweight Saudi Arabia and Kuwait. In Saudi Arabia we see fiscal
adjustment as an ongoing headwind to growth and which we see as low beta to EM with
potential MSCI EM index inclusion still at least two years away. In Kuwait, 2016’s election
resulted in a more obstructive parliament making passing fiscal reform measures
politically tough and where we continue to see corporate transparency as poor.
We understand that neutral weight in Pakistan means having zero in Pakistan for frontier
funds benchmarked against MSCI FM following Pakistan’s transition to MSCI EM. We
don’t necessarily think Pakistan warrants a zero weight but want to indicate that we are no
longer as positive on the market as we have been since early 2015. For Nigeria, Frontier
investors are very underweight. Given the still less than transparent new FX window, we
don’t expect that mainstream international funds will leap into the market, but we are
signalling that we believe that frontier investors should do work on the market now. And
finally, for Saudi Arabia, which is not included in either MSCI EM or DM, an underweight
effectively means zero.
In this report
Our country over and underweights are summarised on page 9.
Our top stock ideas on page 12.
Country summaries from page 25
We have introduced a fifth factor to our top-down asset allocation model
(which includes GDP acceleration, bank lending acceleration, scope for credit
upgrades and cheap currencies). We now add in the interest-rate cycle. The
model tells us to look at Russia, Turkey, Greece and perhaps Egypt in EM; and
to be cautious on UAE and Qatar. In Frontier, Kazakhstan, Argentina and
Morocco look interesting; Sri Lanka, Jordan, Saudi Arabia, Kuwait and Oman
less so. Looking out to 2018, in EMEA the data supports becoming more
interested in Turkey, Egypt and the UAE and fading Greece, Russia, CE3 and
Qatar; and in Frontier becoming more interested in Kazakhstan, Kenya,
Nigeria, Bangladesh and Saudi Arabia, Kuwait and Oman, while fading
Argentina and Romania. See page 77 for more.
7Renaissance Capital
12 June 2017
The Focal Point
EM and Frontier from above on p 51 takes a look at growth, acceleration,
liquidity, valuation and what’s happening with all the various MSCI Index
changes affecting EM and FM.
8Renaissance Capital
EMEA strategy 12 June 2017
The Focal Point
Figure 1: Renaissance Capital country summaries
Country Weighting Positive Negative
Emerging
Accelerating economy, better-than-expected disinflation 4.1% CPI almost
Lowered conviction. Oil rangebound, pre-election period should bring
at the CBR’s 4.0% YE target; “below the radar” reforms, fiscal discipline.
few reform surprises. Long-term growth an issue. US investigations
Highest dividend yield in EM. Potential for stronger-than-expected rate
mean sanctions relief off the table, and there is talk of codifying existing
Russia OW cuts given disinflation and RUB strength (real rates 5%). Range-bound
sanctions. EM funds already overweight. Oil/strong rouble squeezing
oil argues for renewed focus on reform post election and continued
EPS. Sistema headlines a negative, though we believe company
pressure to improve governance at state companies. Real wages turned
specific.
positive in August; we see retail sales following in 2Q.
Eurozone PMI at 57 good for export demand; end of dollar rally less of a
currency headwind; growth acceleration part driven by EU budget cycle: Strong performance to date; PiS negative for state owned dividend
Poland OW GDP grew 4% YoY in 1Q17. CHF mortgage rhetoric softening. End of story; bank regulation still a risk; political tensions with the EU expected
deflation. EM funds underweight. 3.2% 10-year yields supportive for to continue.
equity valuations.
May PMI 62.1, an all-time high. Highest upwards earnings revisions in Risk of populist policies pre-April 2018 elections. EM funds slightly
Hungary OW
EM. 3.0% 10yr yields supportive for equity valuations. overweight, just 0.32% of MSCI EM (which contains only three stocks).
A tactical trade only. Economy stuck in middle income trap; 120% loan-
Government using balance sheet to support lending growth; exposure to
to-deposit ratio limits how much further bank lending can grow. EM
Eurozone recovery; some political normalisation possible, 2H disinflation
funds overweight; 65% foreign ownership in line with 10-year avg.
Turkey OW easing pressure on central bank (weighted avg cost of funding 12%).
Nationalist-populist rhetoric including pressure on the CBT keeps
Logic would suggest a more pro-business stance to boost growth and job
investors edgy. CPI of 11.7% needs to come down given 10.5% 10yr
creation ahead of the 2019 elections.
TRY government yields.
Low beta to EM. PMI survey data suggesting labour shortages
Second highest dividend yield of any country in MSCI EM of 5.8% vs
Czech N becoming a constraint on growth. Just 0.2% of MSCI EM (and only four
0.8% 10-year yields supportive for equity valuations.
stocks). Lack of interesting corporate stories.
Brexit suggests greater willingness of the EU to strike a deal. New Recovery delayed, with PMI still sub-50. Debt forgiveness politically
Democracy leading opinion polls. 10-yr bond yields down from 8.5% in toxic in Germany - a more comprehensive deal unlikely before German
Greece N
September to 6% – yields could decline further if negotiations lead to QE elections in September. Syriza government unpredictable. At 0.38% of
inclusion, supportive for banks (on 0.3x BV). MSCI EM, easy to ignore.
…but Zuma could stay in power until 2019 and have strong influence
Currency has held up well despite political headwinds suggesting no over successor - politics looks likely to keep international investors on
South Africa N SARB hikes needed. Political noise could yet turn out to trigger positive the sidelines, and locals long hedge stocks. ZAR could be vulnerable to
change… political noise. Economy failing to deliver growth or make an impact on
equality or unemployment, only a small underweight EM funds.
The equity story needs better visibility of rates coming down and/or
Very cheap currency, attractive bond yields, rate hike negative for growth
easing pressure on the consumer, perhaps a story for later in 2017.
Egypt N but good for central bank credibility, FX availability. Expect investment to
Only 0.12% of MSCI EM, easy to ignore. Social issues related to the
pick up once rates begin to fall.
adjustment and security risks remain.
Low beta to EM recovery given pegged currency, oil exposure.
Economies likely to recover in 2018; higher US rate environment good Economies pressured by fiscal discipline. Dubai property prices still
GCC UW
for the banks. Pegged currencies. Investors underweight. falling. Intra-regional politics, with Saudi Arabia, UAE, Bahrain and
Egypt cutting ties with Qatar.
Note: OW=overweight, N=neutral, UW=underweight
Source: Renaissance Capital
Figure 2: MSCI EMEA over/underweights
Over/underweight
Overweight
Neutral
Underweight
Russia
Czech
Qatar
Turkey
Egypt
Poland
Greece
UAE
Hungary
South Africa
Source: MSCI, Bloomberg
9Renaissance Capital
Frontier strategy 12 June 2017
The Focal Point
Figure 3: Renaissance Capital country summaries
Country Weighting Positive Negative
Frontier
Economic acceleration: we expect 2.3% growth in 2017; the KZT
Kazakhstan OW appears cheap on our REER measure. Modest rate cuts still to Just two stocks in MSCI Kazakhstan; only 1.9% of MSCI Frontier.
come. Potential for (positive) surprises on reform agenda.
Growth reacceleration in 2017. Market derated from peaks. Fiscal Currency appears expensive, though current account in surplus.
deficit suggests progress on privatisations. Frontier funds Bank reform slow. US withdrawal from TPP trims trade upside.
Vietnam OW
underweight given ownership limits. Inflation back under 4% year- Leverage could become a concern in a slowdown: bank lending
end target. Current account back in strong surplus. 131% of GDP (gov’t debt 63% of GDP).
Strong GDP rebound expected in 2017. Inflation has come down
Wage settlements have been running near 20% ahead of mid-term
from 41% at end-2016 (Buenos Aires) to 29%, with further
elections in October which Macri can’t afford to lose. Central bank
declines expected though not to the central bank’s 12-17% target.
Argentina OW raised rates from 24.75% to 26.25% in April – good for credibility,
Potential MSCI EM re-inclusion story (announcement due on
and should come down again as inflation declines. Valuations no
June 20). Frontier funds still underweight; potential for rate cuts
longer cheap.
later in the year.
The Georgian lari has stabilised, and the rebounding lira helps.
Currency rally has brought GEL back to close to fair value. We
Robust growth: we expect above consensus 4.2% in growth in
have increased our end-2017 inflation forecast to 5.8%. Post-rally,
Georgia OW 2017 and 4.1% in 2018. Exports, remittances and tourism all
banks are no longer cheap (1.75-2x trailing book value) though
supportive, while a pick-up in state infrastructure spend and
RoE is strong.
easing tax regime should help growth.
Potential beneficiary of frontier fund sales from Pakistan;
investment approaching 30% of GDP; exports growing and Frontier funds already slightly overweight. Poor corporate
Bangladesh OW
current account near balance, elections not until late-2018/early- transparency, market not cheap on 16.8x 12M FWD P/E.
2019. Good industrialisation story.
Accelerating economy, improved security, China-sponsored Reforms on hold pre-summer 2018 election; associated election
investment in infrastructure, electricity good for long term growth. risks; current account deteriorating, exports stagnant; big off-index
Pakistan N
EM transition brings valuation discount to India (11x vs 17x 12M holding for frontier funds who are likely to be net sellers. Just
FWD P/E) in to sharper focus. 0.13% of MSCI EM.
Starting to overheat – current account deficit doubled to 2.4% of
Likely to be the fastest growing economy in the EU in 2017.
Romania N GDP in 2016. Inflation picking up – the CBR expects 1.6% in 4Q17
Frontier funds underweight.
and 3.1% in 4Q18. Budget deficit could breach EU’s 3% limit.
Strong agriculture led rebound in 2017. New government formed, Opening up of FX markets in Nigeria, Egypt eroding Morocco as a
announced continued subsidy removal. Exposure to Eurozone safe haven African market. Premium valuations given ownership
Morocco N
recovery. Big underweight in Frontier funds. Currency appears by local pension funds. Low beta market, private sector debt levels
close to fair value. relatively high.
Market has run hard since March (banks are back to 1.5x BV,
Interest rate caps could be eased post-election, which should
Safaricom at all-time highs), inflation spike not to reverse till year
allow credit growth to pick up. Frontier funds only near neutral.
Kenya N end (though we don’t anticipate rate hikes). Elections in August.
Easing impact of drought. 2018 looking better for growth and
Currency appears expensive on our REER model, but reserves
inflation. Infrastructure projects being delivered.
(and IMF support) are strong.
I&E currency window an important development, which could New currency window still not transparent, investors treating with
ultimately pave the way for a unified exchange rate. Valuations caution. Challenges in unifying remaining exchange rates,
cheap and frontier funds deeply underweight. Potential economic implementing reforms in window before February 2019 election.
Nigeria N
rebound. For investors who can get in close to 400, we MSCI to rule in mid-June about ongoing eligibility for MSCI FM
recommend starting to close underweights. Vice-president very inclusion. Impact of devaluation on banks particularly second tier
pro-market. banks needs to be watched.
Potential MSCI EM entry (2.4% weight ex-Aramco), but not till
Earliest MSCI entry date 2019 still some way off. Low beta to
2019. Introduction of t+2, short selling, new QFI rules a positive.
Saudi Arabia UW emerging markets. Sluggish growth for 2017: just 0.4% down from
Economic reforms headwind to economy despite restoration of
1.4% in 2016 according to the IMF.
bonuses and allowances. Foreigners own just 4% of the market.
2016’s election resulted in a more obstructive parliament:
opposition groups hold 24 of 50 seats in the National Assembly:
2018 rebound story after negative growth in 2017. Major
implementation of policy an issue (not one parliament has lasted to
Kuwait UW underweight for Frontier funds. Fiscal breakeven oil price just
full term since 2006). Fiscal reform measures still politically tough
$49.1/bl making Kuwait defensive within the GCC to low oil prices.
amidst infighting over succession to the 87-year old Emir.
Company transparency poor, and guidance consistently missed.
Off-Index
Big vote for glasnost and perestroika Iran-style, with Rouhani’s Banking sector reform painfully slow; currency rates have yet to be
re-election in the Presidential vote. End of the oil production unified. Still off limits to most international investors given lack of
Iran *
ramp-up dividend should pave the way for reform. International international custody and due diligence requirements to satisfy
investors can now use the parallel market rate to bring in capital. compliance with remaining sanctions.
Note: OW=overweight, N=neutral, UW=underweight
Source: Renaissance Capital
10Renaissance Capital
12 June 2017
The Focal Point
Figure 4: MSCI Frontier over/underweights
Over/underweight
Overweight
Underweight
Saudi Arabia
Argentina
Kenya
Nigeria
Kuwait
Vietnam
Georgia
Pakistan
Romania
Morocco
Kazakhstan
Bangladesh
Source: MSCI, Bloomberg
11Renaissance Capital
RenCapα 12 June 2017
The Focal Point
Figure 5: RenCapα – investment case
Upside
Name Ticker Country CP* TP Rating Case
potential
We expect Tencent to be the main driver of shares in Naspers in the near term
and remain positive in this regard. Mobile games have been the main upside
South driver in Tencent’s results over the past few years, but we think growth will
Naspers NPN SJ ZAR2,645.5 ZAR3,460.0 OUTPERFORM 30% inevitably slow. However, we expect mobile advertising to increasingly pick up the
Africa
slack and drive upside surprises. We reiterate our OUTPERFORM rating and
ZAR3,460 TP.
While Sberbank’s share price notably re-rated last year, we think the story will
have legs in 2017, helped by macro stabilisation, positive geopolitical risk, and
Sberbank SBER RX Russia RUB154.7 RUB215.0 OUTPERFORM 39% attractive value and returns. Notwithstanding all the challenges of the past several
years, Sberbank remains the only large-cap liquid banking stock (except
FirstRand) delivering a 20% RoE benchmark for best-in-class EMEA banks.
We believe ongoing strong LfL trends at Pyaterochka and aggressive expansion
should lead to X5’s top-line outperformance in the near-to medium term.
Combined with profitability improvements, this is likely to result in a best-in-class
X5 FIVE LI Russia $36.6 $41.0 OUTPERFORM 12% 2016-2019E earnings CAGR of 37% in dollar terms. However, X5 shares continue
to trade on an 18% / 21% discount to Lenta / Magnit on 2017E P/E, which we
think is unjustified.
Our top pick of the SA hospitals is Mediclinic, which has achieved the greatest
geographical diversification and has the strongest management team of its SA
South peers, in our view. We remain positive on the company’s Middle East expansion
Mediclinic MDC LN GBP8.0 GBP9.5 OUTPERFORM 23% where we see a structural growth story in the hospital sector due to a high unmet
Africa
demand for quality healthcare at present and increasing lifestyle-related diseases.
We forecast this exposure to drive superior growth in the medium term in pounds.
Sustainable aluminium prices, robust cost control, moderate capex, and persistent
dividend flow from Norilsk Nickel have created a favourable environment for Rusal
operations. The company, which five years ago was trading at 9x debt/EBITDA is
Rusal 486 HK Russia HKD3.8 HKD8.0 OUTPERFORM 112% set, on our estimates, to become debt-free in five years. We see an unfolding
equity story for Rusal, with ongoing deleveraging and wider opportunities for
dividend payments.
Our calculations show that InterRAO could cover its cost of modernisation with
only a single year of operational cash flow and would still be able to grow its
dividend payout (of up to 145%) without harming either its balance sheet or its
modernisation drive and still be in cash-accumulation mode. InterRAO’s financial
InterRAO IRAO RX Russia RUB3.9 RUB7.6 OUTPERFORM 95% strength is unprecedented in the sector and we believe it is well equipped to
deliver value to shareholders for at least the next 10 years while the underlying
value is yet to be unlocked – at 2017E EV/EBITDA of 2.1x (a 70% discount to
international peers).
On a forward P/E of 16.9x, on our estimates, Tiger Brands remains the most
attractively valued of the SA food producers, in our view. We believe Tiger has the
strongest portfolio of brands and dominant market positions in the SA FMCG
Tiger South space, which we think the other food producers will battle to replicate owing to a
TBS SJ ZAR386.0 ZAR460.0 OUTPERFORM 19%
Brands Africa scarcity of branded food acquisitions available. With a new management team in
place, we believe there is upside potential from cost-cutting and efficiency gains
and a renewed focus on innovation and marketing.
We forecast Unipro to be the highest dividend payer, and owning the youngest
capacity fleet in the sector should enable it to undergo modernisation without any
major uptick in capex. Unipro offers current shareholders an accumulated
dividend yield of 100% over the next six years. Despite trading at a relative
Unipro UPRO RX Russia RUB2.6 RUB3.6 OUTPERFORM 37% premium to Russian peers (2017E EV/EBTDA of 3.1x, or an 11% premium to the
Russian peer average), we forecast Unipro could deliver a 9% annualised
dividend yield in 2017 and 2018, growing to a 17% yield from 2019 onwards as
the Berezovskaya new unit is recommissioned.
After two years of sluggish volume growth, we now see international operations
(which make up 60% of total EBITDA generation) picking up on the back of
stronger economic activity in Pakistan and stabilised currency in Kazakhstan.
Strong and profitable growth abroad should reverse downward revisions in
Coca-Cola
CCOLA TI Turkey TRY37.8 TRY43.6 OUTPERFORM 15% consensus estimates. We are now 6% ahead of FY17 EBITDA Bloomberg
Icecek
consensus. CCI trades at 8% discount to peers, at 9.2x FY17E EV/EBITDA.
Given CCI’s attractive valuation and improved short-term outlook, along with
superior long-term growth drivers, we think CCI deserves to trade premium
compared to peers (at least 10% premium).
All data as of close 5 June 2017
Source: Bloomberg, Renaissance Capital estimates
12Renaissance Capital
12 June 2017
The Focal Point
Figure 5: RenCapα – investment case (continued)
Upside
Name Ticker Country CP* TP Rating Case
potential
We believe Ulker is a great company to play the normalisation we expect in Turkey
after the referendum. The stock has underperformed domestic and global peers
over the past nine months, largely, in our view, due to media reports of criticism
and possible legal action against the company – management denied these reports
and said it had faced no legal action. Operationally, the company continues to
benefit from restructuring and inorganic growth. Assuming that another acquisition
in Saudi Arabia completes in 2017, our FY17/FY18 net income estimates are
Ulker ULKER TI Turkey TRY20.7 TRY24.8 OUTPERFORM 20% 8%/12% ahead of consensus. Ulker trades at an FY18E P/E of 15.4x and
EV/EBITDA of 9.6x, on our estimates, corresponding to c. 25% discounts to
Bloomberg’s Global Confectionery Index averages of 19.3x and 11.5x,
respectively. The stock has had a strong correlation with global peers in the past
and has tended to trade in line with this index. Given what we view as Ulker’s
stronger growth profile and improving margins, we see the current discount to
peers as unjustified.
Strong results and FCF in 2016 and a low ND/EBITDA translated into adoption of
new dividend policy allowing the company to pay c.100% of FCF (9% yield on
2016) with the possibility of interim dividends. We think GLTR’s operating leverage,
Globaltrans GLTR LI Russia $8.0 $9.1 OUTPERFORM 14% positive backdrop in the open gondola market (despite headwinds in rail tanks) and
balanced capex will lead to strong FCF in 2017. Moreover, we think given the
difficulty in forecasting the timing of tariff adjustments, the company is likely to see
consensus upgrades over the next reporting periods.
We see upside potential in TBC as we incorporate the Bank Republic (BR)
consolidation in our model. We estimate TBC trades at a 14-17% discount to the
TBC TBCG LN Georgia GBP17.0 GBP19.4 OUTPERFORM 14% BGEO stand-alone banking business, and, in our view, is the better play on
Georgia's recovery story.
We rate El Sewedy Electric as OUTPERFORM as it is the largest beneficiary of the
El Sewedy devaluation and is continuing to expand its backlog, ensuring the growth of the
SWDY EY Egypt EGP88.0 EGP125.0 OUTPERFORM 42%
Electric turnkey business.
With 75% market share, we believe Telecom Egypt is well positioned to benefit
Telecom from increasing broadband penetration in an under-penetrated market; the best
ETEL EY Egypt EGP10.4 EGP15.9 OUTPERFORM 54% network in the market (optic-fibre) ensures dominance in the wholesale segment
Egypt
and provides a solid and diversified source of income to its revenue stream.
Grindrod is our top pick in the general industrials space. We believe dry bulk
shipping rates have room to recover over the next few years as supply is
South constrained and demand begins to recover. Dry bulk shipping terminal rates have
Grindrod GND SJ ZAR11.0 ZAR13.8 OUTPERFORM 26%
Africa recovered from their lows of 12 months ago and volume has recovered with higher
commodity prices and ring-fenced rail capacity.
Given the company’s relative size, management’s market insights and focus on
brands and innovation, we believe Rhodes is well positioned to continue gaining
Rhodes South market share and expanding in the regional market. While our outlook for the
RFG SJ ZAR25.3 ZAR30.0 OUTPERFORM 18% international division is muted in the medium term, we believe regional growth will
Food Africa
more than compensate for this. In our view, Rhodes offers the best growth potential
of the SA food producers under our coverage in the medium term.
Although current ad market trends are strong, supporting Yandex’s top-line growth,
the company continues to see declining search share on mobile, with no progress
on the FAS / Google case, and we do not expect this negative structural trend to
Yandex YNDX US Russia $27.2 $17.2 UNDERPERFORM -37% reverse in the medium term. In the near term, we think the market under-estimates
the investments in taxi business required to successfully compete against Uber and
Gett, and we believe that 2017 EBITDA consensus needs to come down, driving
share-price underperformance over the next 6-12 months.
DSY remains a high-conviction UNDERPERFORM call as we expect a potential
Discovery South
DSY SJ ZAR128.3 ZAR85.0 UNDERPERFORM -34% rights issue or a material slowdown in new business given its capital and liquidity
Holdings Africa
constraints.
All data as close of 5 June 2017
Source: Bloomberg, Renaissance Capital estimates
13Renaissance Capital
Introduction 12 June 2017
The Focal Point
Back in November (when we published Hotel California) it looked as though 2017 could
be a tough year for EMs as Donald Trump’s unexpected election victory pointed to greater
fiscal expenditure, higher inflation, a steeper path for US interest rates, and a stronger
dollar all mixed in with greater protectionism. All in all, a pretty toxic mix for EM equities,
which sold off 10% in dollars from their 3Q peak.
By accident if not design, 2017 is turning out to be much better than anticipated, with EM
equities up 17% YtD, more than recouping their 4Q losses, and the best start to a year
since 2009. EM equities have recovered their post-US election underperformance vs DM.
Why the sudden turnaround for EM?
1. Protectionism fears subside. Despite campaign rhetoric, Trump has
backpedalled on labelling China as a currency manipulator and/or withdrawing
from NAFTA. A new trade deal with China has even been unveiled, goals for
NAFTA’s renegotiation are modest, and the door has been opened to reviving
EU trade talks, plans for a border adjustment tax have met resistance though
Trump has criticised Germany’s trade surplus with the US.
Figure 6: Exports to US, 2015, % of exports and of GDP (capped at 30%) Figure 7: ‘Death spiral’ of world trade during the Great Depression ($mn)
Exports to US, % of total exports, 2015
Exports to US, % of GDP, 2015 January
4000
30% 81% December February
3000
25%
November 2000 March 1929
20%
1000 1930
15%
October 0 April 1931
10%
1932
5%
September May 1933
0%
Chile
Korea
Russia
Peru
Jordan
Kuwait
Bahrain
Serbia
South Africa
Greece
Lithuania
Malaysia
Turkey
Czech Republic
Qatar
UAE
Bangladesh
Oman
India
Philippines
Indonesia
Poland
Mauritius
Argentina
Estonia
Lebanon
Nigeria
Mexico
Ivory Coast
Colombia
Tunisia
China
Brazil
Taiwan
Croatia
Romania
Vietnam
Kenya
Slovenia
Thailand
Egypt
Hungary
Senegal
Sri Lanka
Pakistan
Morocco
Kazakhstan
August June
July
Source: Bloomberg Source: League of Nations’ World Economic Survey, 1932-33
2. Political noise in the US has been a hurdle to passing tax legislation (including
corporate tax cuts and incentives for US companies to repatriate overseas
earnings) as well as healthcare reform and infrastructure spending, with
commentators suggesting plans are likely to be watered down, and a 2018 rather
than 2017 story now.
3. US inflation expectations ease. US inflation expectations have come down as
so-called Trumpflation has looked less likely: five-year inflation swaps have
come down from a 2.6% peak in January to sub 2.3%; while headline inflation
has come off from 2.7% in February to 2.2% in April. 10-year bond yields have
fallen from 2.6% in March to 2.2% by end May.
4. Fed expectations have stabilised. And with it the pace of US tightening: after
an expected June hike by the Fed, the market is pricing in only a 42% chance of
another hike by year-end; meanwhile the European Central Bank (ECB) is not
expected to start tapering QE until 1H18. Only gradual rate hike expectations are
allowing yield seeking flows into EM fixed income to continue – the EMBI global
spread has come down from a peak of 407 in November to 322 in May, but is
still above the 240 post-GFC low, which could suggest that “picking up pennies
in front of a steamroller” could have further to go.
14Renaissance Capital
12 June 2017
The Focal Point
Figure 8: US Inflation expectations falling… Figure 9: Fed Fund futures probabilities indicate one more hike to come
US inflation Swap Forward 5y5Y Dec 17 Rate expectations Dec 18 Rate expectations
3.4 2.00
3.2
1.75
3.0
2.8 1.50
2.6
1.25
2.4
2.2 1.00
2.0
0.75
1.8
1.6 0.50
Jul-10
Jul-11
Jul-12
Jul-13
Jul-14
Jul-15
Jul-16
Jan-10
Jan-11
Jan-12
Jan-13
Jan-14
Jan-15
Jan-16
Jan-17
Jul-16
Oct-16
Apr-17
Jun-16
Aug-16
Sep-16
Nov-16
Dec-16
Jan-17
Feb-17
Mar-17
May-17
Jun-17
Source: Bloomberg Source: Bloomberg
5. Dollar stable/lower – on a trade weighted basis, the dollar peaked at the end of
2016, having gained 6% in the aftermath of the US election. The dollar has
subsequently given back all almost all its post-election gains as inflation
expectations have come down and with it bond yields and expectations of Fed
tightening; tax legislation (including incentives for corporates to repatriate
overseas earnings) has hit obstacles and fears of overt protectionism have
eased. We note that CME speculative positioning is now long euro vs dollar.
Figure 10: Dollar rally – may be running out of steam? Figure 11: Market weighted REER
MSCI EM REER LT avg
Dollar Index
EM Ex China REER LT avg
105 125
100 120
95 115
90 110
85 105
80 100
75 95
70 90
65 85
Jul-10
Jul-11
Jul-12
Jul-13
Jul-14
Jul-15
Jul-16
Jan-10
Apr-10
Oct-10
Jan-11
Apr-11
Oct-11
Jan-12
Apr-12
Oct-12
Jan-13
Apr-13
Oct-13
Jan-14
Apr-14
Oct-14
Jan-15
Apr-15
Oct-15
Jan-16
Apr-16
Oct-16
Jan-17
Apr-17
Jan-95
Jan-96
Jan-97
Jan-98
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
Jan-13
Jan-14
Jan-15
Jan-16
Jan-17
Source: Bloomberg Source: MSCI, Bruegel, Bloomberg
Should investors continue to chase the rally? We believe yes, but with the caveat that with
EM up 21% from the November lows (and the S&P 500 up 16%), markets are likely to
encounter profit taking at some stage.
We see five important drivers as supportive for EM equities over the remainder of 2017
1. Synchronised global recovery. The IMF is expecting a more synchronised
global recovery this year. For the first time since 2007, the IMF expects all the
top-40 largest countries in the world to show positive growth (with growing
countries in aggregate representing 98% of global GDP). 64% of global GDP is
expected to be in countries which have accelerating growth, up from 29% in
2016. And for the first time since 2007, all countries in MSCI EM and MSCI DM
15Renaissance Capital
12 June 2017
The Focal Point
are expected to be showing positive growth. In 2018, all EM regions should be
growing faster than DM.
Figure 12: 2017E GDP growth and acceleration Figure 13: 2018E GDP growth and acceleration
2017E Real GDP Growth (% YoY) 2017E GDP acceleration (ppts) 2018E Real GDP Growth (% YoY) 2018E GDP acceleration (ppts)
7% 7%
6% 6%
5% 5%
4% 4%
3% 3%
2% 2%
1% 1%
0% 0%
-1% -1%
EM-Asia EM FM EM-EMEA DM EM-LatAm EM-Asia EM FM EM-EMEA EM-LatAm DM
Source: IMF April 2017 WEO Source: IMF April 2017 WEO
2. Accelerating – but not overheating – global growth. With global headwinds of
fiscal tightening, the euro crisis, deleveraging, the EM/BRIC slowdown and
commodity price collapse all fading: the IMF expects global growth to accelerate
to 3.5% in 2017 (from 3.1% in 2016) and to 3.6% in 2018. No, not exciting
compared with the kind of excesses which saw global growth compound at more
than 5% annually over 2004-2007, and which resulted in a market damaging
spike in commodity prices (and global inflation). There are arguments why
ageing populations, leverage and ‘peak globalisation’ could lead to lower trend
growth – indeed, global working age population growth alone has halved from
2% in 1990 to 1% in 2015.
3. Subsiding political risk. Policy so far in the US has been less anti-trade than
had been feared; Trump’s relationship with Chinese President Xi Jinping has got
off to a better than expected start. Meanwhile, the Austrian, Dutch and French
election results have been market-friendly and recent polls put Germany’s
Chancellor Angela Merkel in a strong position for September’s federal election.
4. EM relative acceleration to DM. After four years of relative deceleration of EM
economies vs DM over 2012-2015, 2016 was the first year of relative EM
reacceleration. The IMF expects this trend to continue in 2017 and during 2018-
2022 (we note that the IMF doesn’t include a US recession in to its numbers, one
would be well overdue by 2022…).
16Renaissance Capital
12 June 2017
The Focal Point
Figure 14: EM-DM relative growth and performance Figure 15: Global growth
MSCI EM relative to DM ($) EM-DM growth (RHS) DM EM World
EM-DM growth (forecast)
300 7 10
6 8
250
5 6
200 4 4
3 2
150
2 0
100
1 -2
50 0 -4
2017F
2018F
2019F
2020F
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
2020
Source: IMF, Bloomberg Source: IMF,
5. Global trade has broken out of its weak trend. Global trade volumes have
broken out of their recent six-year trend of around 0.5% growth and while off
recent peaks are currently running at 1.4% YoY on a three-month moving
average basis (down from 2.6% in January). Meanwhile, the global
manufacturing PMI (52.8 in April) is near five-year highs, the Eurozone’s
manufacturing PMI has surged from 51.7 in August to a flash reading of 57.0 for
May. The US ISM Manufacturing PMI for April was 54.8, up from 49.4 in August,
but off a 57.7 high in February.
Figure 16: Global manufacturing PMI picking up… Figure 17: Global trade breaking out (3m/3m % chg)
60 Global Manufacturing PMI 5%
55 4%
3%
50
2%
45
1%
40
0%
35 -1%
30 -2%
Jul-06
Jul-07
Jul-08
Jul-09
Jul-10
Jul-11
Jul-12
Jul-13
Jul-14
Jul-15
Jul-16
Jul-10
Jul-11
Jul-12
Jul-13
Jul-14
Jul-15
Jul-16
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
Jan-13
Jan-14
Jan-15
Jan-16
Jan-17
Jan-10
Jan-11
Jan-12
Jan-13
Jan-14
Jan-15
Jan-16
Jan-17
Source: Bloomberg Source: Bloomberg
6. Flows turn positive in EM equities –there could be a lot further to go. 2017 to
date, EM equity funds have seen an impressive $28bn of inflows (or 3% of
AUM). 78% of which has been received via ETFs. EM debt funds have seen
$33bn of inflows (or 10% of AUM) YtD. Since EM equity flows turned in June last
year, $37bn has returned to EM equity funds, however this inflow comes after
three successive years of outflows from EM equity funds totalling $155bn (over
2013-16). To date, still less than one-quarter of those outflows have returned to
the asset class (in comparison to EM debt, where of $61bn has returned of the
$72bn of outflows over the same period (or 85%).
17Renaissance Capital
12 June 2017
The Focal Point
Figure 18: EM equity and debt flows since peak cumulative inflow (peak = 0) Figure 19: EM headline EPS growth and consensus forecasts
Cumulative EM equity flows, $mn EM EPS growth, % YoY Forecast
Cumulative EM debt flows, $mn (RHS)
- - 60%
-20,000 -10,000 50%
-40,000 40%
-20,000
-60,000 30%
-30,000 20%
-80,000
-40,000 10%
-100,000
-50,000 0%
-120,000
-60,000 -10%
-140,000
-20%
-160,000 -70,000
-30%
-180,000 -80,000 -40%
Feb-13
May-13
Aug-13
Nov-13
Feb-14
May-14
Aug-14
Nov-14
Feb-15
May-15
Aug-15
Nov-15
Feb-16
May-16
Aug-16
Nov-16
Feb-17
2017E
2018E
2010
2011
2012
2013
2014
2015
2016
Source: EPFR Source: Bloomberg
7. Earnings starting to drive the EM rally. The EM rally appears to be being
supported by earnings. Though MSCI EM is up 17% YtD, its 12M FWD P/E has
remained close to 12x. While the valuation is not in itself amazingly cheap (vs
EM’s own history) what it does show is that the current rally is being driven
primarily by earnings. This year consensus is suggesting 28% dollar EPS growth
for MSCI which if achieved would be the highest EM earnings growth since 2010
(if 28% earnings growth is achieved, an additional 10% move in MSCI EM by
year-end could be warranted on earnings alone). The cycle high for the 12M
FWD P/E of MSCI EM is 12.8x.
8. Not much of a catch-up after six years of underperformance. The EM
rebound since the November loans has only reversed the post-election
underperformance of MSCI EM vs DM. MSCI EM’s cumulative
underperformance vs DM was 50% over May 2010 – January 2016; the recent
EM rally has seen EM regain only about 14% of that relative underperformance.
However, poor EM earnings performance over this period suggests that much of
this underperformance may already be ‘baked in’.
Figure 20: MSCI EM vs MSCI DM since EM’s inception
MSCI EM relative to DM
400
350
300
250
200
150
100
50
Jan-88
Jan-90
Jan-92
Jan-94
Jan-96
Jan-98
Jan-00
Jan-02
Jan-04
Jan-06
Jan-08
Jan-10
Jan-12
Jan-14
Jan-16
Source: Bloomberg
9. EM return on equity rebounding – four years of EM RoE declines took MSCI
EM’s trailing RoE from 16.6% in July 2011 to 10.0% by October 2016. Since
then, a modest recovery has seen RoE improve to 11.4%, now slightly higher
than 10.7x for MSCI World.
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