World Investment Outlook - Chapter six: Emerging Markets

Elections in Mexico and Brazil will help to set the tone in Latin America in 2018, especially if those countries follow Argentina’s political drift to the right and its embrace of the market-friendly policies of President Mauricio Macri.

Politics also remains centre-stage in Eastern Europe, even if the result of March’s Presidential Election in Russia looks fairly predictable, with Vladimir Putin looking set to win a fourth term a few months before the country plays host to the FIFA World Cup.

One dominant political figure to have come a cropper, however, is Zimbabwe’s Robert Mugabe after a peaceful coup removed him from office. The winds of change also blew in Saudi Arabia. King Salman sacked his nephew, the 57-year old Mohammed bin Nayef, and gave the role of Crown Prince and deputy Prime Minister to his own 31-year-old son Mohammed bin Salman, who promptly launched a corruption crackdown.

A new addition to the febrile geopolitics of the Middle East is the Gulf States’ move to cold-shoulder Qatar, with Saudi Arabia and Dubai leading the way.

One defining moment for emerging markets in 2018 could come in the form of Saudi Arabia’s flotation of a 5% stake in its national oil company Aramco, assuming it goes ahead. Doubts persist as to whether the firm attracts Riyadh’s reportedly desired $2 trillion valuation or not.

Economics

In Africa, Nigeria is just crawling out of a deep and painful recession, but a lot more is needed for Abuja to become an oil boom-town again. In fact, even an oil price of $64 leaves a lot of oil producing-nations in deep financial trouble, if Fitch’s estimate of what oil price they need to break-even on their Government spending plans is even close to the mark. Bahrain, Oman and Saudi Arabia all need higher oil and pretty fast – if not their currency pegs could start to come under strain.

Many oil producers still need higher crude prices to balance their budgets

Source: Fitch

Russia is certainly struggling. Inflation may be cooling but low oil prices are straining its finances and ability to pay State workers, so it is no surprise to see the Bank of Russia try to steady the ship with a slew of interest rate cuts down to a three-year low of 8.5%.

Turkey looks to have bounced back strongly from the disruption caused by 2016’s attempted coup, although research from Germany’s Commerzbank did describe the 6.5% year-on-year GDP growth figure published for the second quarter as “highly questionable.”

Elsewhere in Eastern Europe, Poland, Hungary and the Czech Republic, known as the CE3, are seen as players on the economies of Western Europe, especially Germany, and the strength shown by the latter is bringing signs of classic mid-cycle growth pressures, notably wage increases, across the region – car maker Volkswagen had to dole out a 14% pay rise in Slovakia to stave off a strike.

Yet central banks remain reluctant to tighten policy too fast too soon – Hungary even cut again in September – although the Czech Republic scrapped the koruna’s peg to the euro and watched the currency surge. That may have the result of cooling growth a little anyway but it also shows how strong growth is in the region at the moment.

Relative stability in Argentina under a market-friendly President, a return to growth in Brazil and peace in Colombia after 53 years of civil war all provide a more upbeat backdrop for Latin America. However, President Trump’s attempts to renegotiate the North American Free Trade Agreement (NAFTA) is a concern for Mexico, which enjoys a hefty $59 billion trade surplus in its dealings with the USA.

Markets

The African and Middle Eastern region did relatively poorly in 2017, as oil prices failed to make convincing gains, Israel paddled sideways owing to a terrible performance from drug developer Teva and Qatar came under political and economic pressure from its neighbours in the Gulf.

Africa & the Middle Eastern markets ranked last out of eight in 2017

Source: Thomson Reuters Datastream, based on MSCI FTSE Middle East & Africa index. Total returns in sterling terms, 1 January to 30 November 2017.

Eastern Europe fared only a little better, ranking seventh, despite 20%-plus gains in Poland’s WIG and Hungary’s BUX indices. The problem lay with Russia, which has Russia’s 63% weighting in the MSCI Eastern Europe index.

Eastern Europe performed relatively poorly in 2017

Source: Thomson Reuters Datastream, based on MSCI Eastern Europe index. Total returns in sterling terms, 1 January to 30 November 2017.

A developing Russian banking crisis did not help, as two of the country’s top 12 lenders, Okritie and B&N, sought State aid, and nor did oil’s failure to make any headway beyond $55.

The RTS index lost ground in local currency terms as the old rule about multiplying the Urals oil price by 20 to get the benchmark’s level held pretty firm. The determination of both OPEC and non-OPEC members, the latter egged on by Moscow, to hold firm on oil production cuts to the end of 2018 at least offers some grounds for encouragement, as this could support the price of crude.

The oil price still has a huge influence on Russia’s stock market

Source: Thomson Reuters Datastream

After a return to favour in 2016, Latin America added fresh gains in 2017. It actually did well enough to provide the second-best sterling-terms, total returns out of the eight regions, lagging on Asia, to complete a remarkable turnaround after the four straight seventh or eighth-placed rankings of 2012-2015.

Latin American markets ranked second out of eight in 2017

Source: Thomson Reuters Datastream, based on MSCI Latin America index. Total returns in sterling terms, 1 January to 30 November 2017.

Brazil’s Bovespa and Argentina’s Merval led the way although a rally in the Mexican Bolsa from a November 2016 (post-Trump-victory) low of 44,364 to a summer high of 51,700 contributed too. However, the Bolsa lost ground towards the end of the year as the NAFTA talks began and interest rates reached 7% after four rate hikes, so the combination of the Presidential election, trade policy and the pace of any monetary easy is likely to be crucial for 2018.

If one company is set to dominate 2018’s emerging market headlines it is likely to be Saudi Arabia’s Aramco.

As part of an ongoing programme to open up its capital markets – and in return get greater access to overseas investors – Saudi Arabia is pressing ahead with its plan to float its national oil company, Aramco.

The company’s financials remain shrouded in mystery, although London and New York are nevertheless fighting it out to be the home of the listing, which will see Riyadh initially sell a 5% stake.

The lack of financial information makes it difficult to put a potential valuation on the stock, although the press continues to bandy around a figure of $2 trillion, based on the stated reserves figure of 261 billion barrels of oil.

Whether investors, or their appointed fund managers, decide to commit capital to Aramco may partly depend on where it is listed, as well as corporate governance issues and ultimately the all-important valuation, or indeed whether the deal happens at all – there have been press reports that Riyadh may prefer a private placement, potentially with a Chinese buyer.

Russ Mould, AJ Bell Investment Director

Next chapter

Read more from our World Investment Outlook 2018 series:

World Investment Outlook - Chapter one: UK

World Investment Outlook - Chapter two: USA

World Investment Outlook - Chapter three: Japan

World Investment Outlook - Chapter four: Asia

World Investment Outlook - Chapter five: Western Europe

World Investment Outlook - Chapter six: Emerging Markets