Central European currencies and bonds look more attractive than equities. The pegged and otherwise partially fixed exchange rates common across emerging markets, but not in Central Europe, have like a corset squeezed dollar weakness into Euro strength.
This has so far led to a near 25 per cent appreciation of the Zloty against the dollar over the last year but also 11 per cent against the Euro as these currencies have tended to benefit even more. This has boosted imports and growth but with only a modest up-tick in inflation from low levels. The open nature of the economies of central Europe means though that equities are vulnerable to earnings downgrades in a Euro-zone bear market.
Poland and the Czech Republic, with strong fundamentals, seem less vulnerable to external financing drying up than Hungary or Romania. Then again, markets have arguably factored much of the Euro-zone reversal risk into currencies and fixed income, in the form of long Russia, Poland and Czech positions, and under-weights in the big current account deficit countries.
The leeway markets give members of the EU such as Romania compared to Turkey is still marked. Turkey’s external financing needs and oil import bill makes earnings vulnerable. Of concern to fixed income investors is that interest rates haven’t moved up yet. However, we are still highly positive on the currency and fixed income risk in the medium term.
In Russia the equity market looks more attractive in our view. The sectors we favour are those driven by rising incomes and fixed asset investment: consumer sectors and infrastructure. Oil and Dutch Disease argue for further currency strength, whilst inflation continues to edge up.
The central bank is still resisting a rapid appreciation however; attempting to use interest rates more than the exchange rate to control inflation. And local banks’ restricted access to external capital as a result of the credit crunch may help the central bank in its objective as they are forced to go to the central bank for liquidity.
Jerome Booth, head of research, Ashmore Investment Management.
