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Is emerging Europe recovery on hold until a vaccine appears?

Stocks are cheap but they have lagged global equity rally


Kirsten Hastings

Developed markets and North Asian emerging markets; such as China, Taiwan and South Korea, have rebounded and more than recouped their covid-19-related losses.

In comparison, emerging European markets overall have continued to flounder, something Schroders emerging market fund manager Rollo Roscow attributes to a “confluence of factors”.

Lacking tech

In a recent investment insight, he pointed to the more traditional industries that dominate the region compared with tech and e-commerce companies which have led the resurgence in other 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, while 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 debt for banks.”

Roscow added that the persistent low interest rate environment has seen investors favour growth stocks, which have far smaller representation in emerging Europe.

“Meanwhile, the value stocks that dominate the regional index have performed relatively poorly.”

A pound of cure

When it comes to any sense of a rebound, Roscow says his team “would expect the prospect of a sustained global economic recovery and an exit from the pandemic to drive a recovery in emerging European stocks; both in absolute terms and relative to other markets”.

“It seems logical that this hinges on a vaccine being found; although better therapies, or perhaps herd immunity, might also provide the necessary tonic.”

He believes the government stimulus should continue to provide support through 2021.

In addition, the EU recovery is due to begin distributions in the second half of next year.

“We think much of this benefit is yet to be reflected in stock markets.”

Roscow added: “A reflation of economies is typically supportive of old economy stocks, the dominant sectors in emerging Europe.”

Spanner in the works

But that isn’t to say there are not still significant risks.

Away from coronavirus, geopolitics seems the most likely pitfall.

“Key issues to monitor will be the US presidential election in November, and the implications for US-Russia relations.

“A Biden victory could see the US adopt a tougher stance than that taken by president Trump over the past four years,” Roscow said.

“Regional politics, such as the protests in Belarus following presidential elections, are further risks to consider.

“There have been tensions between Turkey and Greece recently, in relation to drilling rights in the Aegean Sea.

“Although we do not invest in Armenia or Azerbaijan, tensions in the Caucasus also bear monitoring given regional geopolitical and energy supply implications.”

Winter is coming

Roscow believes that the next few months may be “an important barometer of what is to come”.

The uncertainty about how the virus will play out will be the determining factor.

“But if fiscal spending continues, and a return to something close to what we previously knew as normality comes to fruition, we think there could be a powerful rally in emerging European stocks.”