Can emerging Europe close the performance gap?

budapest bridge

Across the world, we wait in hope and anticipation for a vaccine for Covid-19. Financial markets reflect optimism that one will soon be found, and that the economic recovery will sustain.

Investors in emerging Europe will be particularly keen for some form of normalisation to come through. Emerging European equities are down almost -30% in US dollar terms so far this year, as measured by the MSCI Emerging Markets Europe Index on 29 September.

While developed markets, and the North Asian emerging markets of China, Taiwan and South Korea have rebounded and more than recouped their Covid-19-related losses, emerging European markets overall have continued to flounder.

There is a confluence of factors behind this performance.

Why have emerging European stocks lagged the rally?

Various letters have been used to illustrate an array of potential paths for the recovery of the global economy. We think a K-shaped best describes what has happened from a stock market perspective.

Technology companies, particularly e-commerce companies, have rallied strongly while banks and old economy sectors have remained under pressure. And this point is equally characteristic of both emerging and developed markets.

In emerging Europe, banks and old economy stocks, such as energy and materials, account for approximately 70% of the index. These sectors tend to move closely with the ups and downs of the economy, whilst the energy sector also faces environmental, social and governance (ESG) challenges over the long term as the world attempts to de-carbonise. The precipitous drop in economic activity over the second quarter collapsed energy demand and prices, as well as leading to concerns around bad debts for banks.

Relative to emerging North Asian markets, there are fewer investment opportunities in technology companies. And long-term thematic growth stories, which are independent of general economic growth, such as electric vehicle batteries, are not present by any comparable degree in emerging Europe.

The low interest rate environment has seen investors favour growth stocks, companies with an outlook for high earnings growth, which have far smaller representation in emerging Europe. Meanwhile, the value stocks, companies which trade at a discount to their investment fundamentals,  that dominate the regional index have performed relatively poorly.

View Full Article – published by Schroders on 1st Octobber 2020