Emerging Europe equities could be a good investment for the last quarter of 2014 for those who are ready to brave the huge risks involved. At least that’s the opinion of analysts and asset managers who are looking at the area.
The European Bank for Reconstruction and Development (EBRD), which has been investing in Central and Eastern Europe and the former Soviet space since the collapse of the Soviet Union, recently downgraded its growth forecast for the region due to tension between Russia and Ukraine.
The weak eurozone economy was another reason for the downgrade, although the EBRD said regions like Central Europe and Turkey had better prospects than others.
However, the region still has its attractions. For one, emerging Europe equities have outperformed Western European peers since March, Edgar Walk, chief economist at Metzler Asset Management, noted in a recent research report.
The valuations for emerging Europe equities are low compared with other emerging markets, mainly because of the tension in Ukraine and the sanctions on Russia, Walk also remarked.
The MSCI Emerging Markets Europe has a 5.5 cyclically-adjusted price/cash flow ratio, compared with the MSCI Emerging Markets’ 10.5 ratio, according to Walk’s research.
The price/book ratio of the MSCI Emerging Markets Europe is significantly lower, at 0.9, than the 1.6 of the MSCI Emerging Markets.
Walk notes that the fundamentals of many economies in Eastern Europe have “remained stable despite geopolitical events and economic shocks,” and that Eastern European countries have successfully reduced their various imbalances since being hit by the 2007 financial crisis.
“If the crisis in the Ukraine does not escalate, we see chances for upside potential for investments in Eastern European equities,” he wrote.
However, growth in the region is likely to remain below that of other emerging markets. The GDP Tracker developed by think-tank Capital Economics, which takes into consideration data on output and spending as a proxy for overall growth, shows a slowdown in emerging Europe.
The region’s two largest economies – Russia and Turkey – are among the worst performers, according to the GDP Tracker.
Emerging Europe equities and the ECB
Commerzbank’s emerging markets analyst Simon Quijano-Evans noted in his outlook for the region that emerging Europe will be the leading beneficiary of the European Central Bank’s monetary easing measures.
“Latest dovish ECB action, including the initiation of (limited) QE, has maximum positive implications for CEE credit (among global EM assets),” he wrote.
The two positives for the region are the disappearance of any inflation problems from countries close to the eurozone and large inflows of funds from the European Union, which co-finances various projects in the region, Quijano-Evans added.
One factor to watch, in his opinion, is the countries’ exposure to commodities, whose prices have been falling.
Kazakhstan, Russia and Ukraine are likely to suffer most due to falls in commodities prices while Turkey, the Czech Republic and Hungary would see the highest advantages.
Analysts at Raiffeisen Bank, an Austrian bank with a big presence in Central and Eastern Europe, expect to see “modest increases” in emerging Europe equities by the end of the year.
“We believe that Romania, Turkey and Czech Republic will lead the pack. Due to the geopolitical and economic situation, we see sub-average potential for Russia and Croatia,” Raiffeisen’s financial analyst Peter Brezinschek wrote in the bank’s outlook for the region.
Raiffeisen raised its allocation to emerging Europe equities by three percentage points to 53% of its portfolio. They lowered their allocation to local currency bonds by 2.7 percentage points, to 37.6%.