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Current capital market report on the Emerging Markets | Emerging Markets

Global overview In October, primarily the developed stock markets resumed their upward trends and gained more than 5 % in aggregate. Emerging markets struggled much more, posting only a modest rise of about one per cent overall. For the year as a whole, they are at risk of underperforming developed markets by the most in about 20 years. However, this applies mainly to the larger companies, which are heavily weighted in the stock market indices. If, on the other hand, the smaller much more cyclical EM companies are considered, the picture is quite different. They can quite keep up with the developed stock markets. If one assumes that the "blue chips" in the emerging markets might recoup at least part of their underperformance, this opens up corresponding catch-up potential for the future. However, there is of course no guarantee for this. Nevertheless, the tailwind for EM equities and bonds should increase somewhat in the coming quarters. We remain optimistic overall, even if no real turnaround in relative performance is evident in the short-term yet.

Equity markets in emerging markets lose substantial ground again versus developed countries

Small caps in emerging markets much stronger than large index heavyweights this year

Continued positive capital flows into emerging markets, but only a fraction of the inflows into US equity markets

In October alone, emerging markets have fallen almost five percent behind the developed ones - that's a lot. Not much is left of the tentative signs of a trend reversal in favour of the emerging markets that we mentioned in the last em-report. For the year as a whole, despite a positive performance in absolute terms, emerging markets are facing their weakest performance in two decades relative to industrialised countries. However, a closer look reveals an interesting phenomenon: small caps in the emerging markets as well as some individual countries (e.g. Russia, India) can keep up very well with the developed markets in absolute terms. Now, small caps generally perform somewhat better over the long term on average than the large "blue chips". However, this high discrepancy (around 17% in the first 10 months in the emerging markets alone) is quite unusual and suggests a price correction in future. Assuming even a partial "mean reversion" and a continued positive global stock market trend, blue chips in the emerging markets should have some catch-up potential and thus also many emerging market equity indices. Yet the capital flows were and are not all that bad. Net-net money continues to flow into the emerging markets, both in bonds and equities. But the amounts are significantly lower than what is flowing in from investors and especially from companies (via share buybacks) in the US, for example. The latter in particular show no inclination to slow down: Another 22 billion US dollars are likely to flow into US stocks in the next 12 months through share buybacks alone - per week, that is! Now, capital flows are a determining factor, especially for the short term. In the long term, however, other criteria, such as valuations, also play an increasingly important role.

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Long-term outlook for EM equities is still promising

Catch-up potential after pandemic-related constraints get lifted

Joint fight against climate change = large investment boost for emerging markets?

Here, even some renowned US investment banks are rather cautious about the US stock markets in the long term. The forecasts of some banks for the coming decade range from slightly negative to minimally positive aggregate (!) returns on an index basis. This does not so much reflect pessimism about the US economy but is rather a function of the massive price rises of the last few years which have already pulled forward gains. Of course, US stocks may still rise more than estimated in these forecasts, but the probability of this is relatively low, based on almost 100 years of stock market history. The long-term picture is different and much more positive in most emerging markets. Thus, it is quite possible that the current year represents a kind of low point from which things can only improve for a while - although it should be noted that this refers to the performance versus developed markets in relative terms., not necessarily in absolute returns, too. But even in absolute terms, too, things are looking quite promising, long-term. In addition to the valuation arguments, which we have repeatedly mentioned here and therefore do not want to rehash, there are other favourable factors. For example, the catch-up potential after the pandemic-related restrictions. Despite lower vaccination rates, demographic factors (younger population with lower susceptibility to severe sickness) could have a positive effect in the future in many of the developing countries. This could mean that the overall susceptibility to new infections is lower than in industrialised countries, which are much more vaccinated but have a much less favourable population structure. And then there is the fight against climate change. COP26 may have dampened some hopes and expectations. But the summit clearly showed one thing: The industrialised countries are called upon to provide massive support to the emerging economies in this fight in the future. For one, the industrialised countries' CO2 footprint is still far larger in per capita terms than that of the developing countries, even of China or India, notwithstanding the CO2 reductions already achieved in the developed world. And secondly, because Europe, Japan and the USA had been able to industrialise without any consideration for the climate and the environment. If they now deny that same path for emerging countries, they will have to offer something in return, and something very substantial at that. This could mean, for instance, investments in sustainable infrastructure and in climate-friendly technologies on a major scale for the emerging markets, financed and aided by the industrialised countries. Even though little was decided and signed in Glasgow in this regard, from today's perspective it seems quite likely that the world will ultimately move in this direction.

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Country focus


China's economic growth continues to suffer from ever new, albeit rather regionally limited, corona outbreaks, energy shortages and the weak real estate sector and related upstream and downstream industries (e.g. construction, steel production). With the exception of the real estate sector, however, these factors are likely to have already had their maximum impact, which argues for an economic acceleration in the coming months. The central bank currently has comparatively little scope for stimulus. At 10.7% p.a., producer prices recently rose faster than at any time since the start of the data series in 1997. Nevertheless, economic growth is likely to bottom out this quarter. The bottlenecks in coal, for example, and the resulting partial production shutdowns have also eased somewhat recently. For 2022, many analysts expect real growth in economic growth between five and six percent. Foreign trade continues to be a pillar of support; domestic consumption of goods and above all services, on the other hand, is still weaker than expected. It is less certain whether investors on the stock markets have already traversed the trough, but there are indications that this might be the case. China's stock markets performed mixed in October. A-shares on the Mainland fell slightly (by about half a percent), while H-shares in Hong Kong rose on average by about 2.7 %.


Economic recovery lags stock market gains, but should accelerate in the coming quarters

The Indian stock market took a breather in October after the strong performance since the beginning of the year and trended sideways. With a gain of around 24 % (in US dollars), it is on par with the major US stock indices. However, it has rushed far ahead of the rather moderate and somewhat sluggish economic recovery so far. One reason for the latter is, among others, a still noticeable risk aversion in the financial system, so that the very extensive liquidity supply by the central bank has so far only partially reached the intended recipients. For the coming year it would therefore be advisable, on the one hand, not to tighten fiscal policy too much and, at the same time, not to make monetary policy too accommodative. Government capex is likely to make an important contribution to growth in the short term, while consumption and private sector investment could follow with some delay. On the inflation front, there has been some easing recently, but the all-clear cannot yet be given. At 4.35 % p.a., the consumer price index was slightly below expectations in September. However, the potential for sticky and rising inflation remains high, especially if the economic recovery accelerates and broadens.


Inflation and fiscal policy unsettle investors and drag down stocks and currency

Brazil's stock market was the biggest negative outlier in October. The stock market index in Sao Paolo fell by almost 7%. For foreign investors, this was compounded by a nearly 5% drop in the exchange rate of the real against the US dollar. Fiscal policy risks are looming, which in turn could drive already elevated inflation expectations even higher. Planned new expenditures in the run-up to the 2022 presidential elections caused unease and fears that the spending cap that had just been painstakingly agreed upon might be severely weakened. Inflation expectations had already risen before that, as had the inflation rate itself. In October, consumer prices recorded the highest monthly jump (+1.25% versus September) in 25 years. In response, the central bank hiked interest rates again sharply from 6.25% to 7.5%. Parliament also wants to cushion the energy price increases somewhat with tax changes on fuel and with vouchers for cooking gas for low-income families.

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Corona pandemic in Russia shows little sign of abating

New tensions between Ukraine and Russia - is a new escalation looming in the Donbass?

Germany stops Nordstream2 certification - tactical manoeuvre or fundamental decision?

The coronavirus pandemic has Russia firmly in its grip. So far, there are only very tentative signs of stabilisation in the number of new infections - despite a largely work-free week at the beginning of November (or home office, as far as possible), i.e. a partial lockdown. The daily number of casualties continues to hit new records. Even the official Russian casualty figures diverge widely. While the government's Covid19 task force reports about a quarter of a million deaths, the Rosstat statistics agency, using other recording methodologies, arrives at a figure of over 450,000, which is almost twice as high. Foreign analysts assume even significantly higher figures of around 750,000, which, however, they only determine indirectly as excess mortality and which, of course, cannot all be directly attributed to the virus. In recent weeks, however, geopolitical events have increasingly taken centre stage. At the end of October, the Ukrainian army shelled pro-Russian rebel positions in the Donbass with a UAV for the first time. Moscow called this a dangerous escalation and a violation of the Minsk agreement, which Kiev denies. Russia suspects that the Ukrainian leadership is planning a new offensive to militarily retake the breakaway republics of Donetsk and Lugansk. Apparently in response and as a deterrent, Russia has moved large numbers of troops and combat equipment to the border with Ukraine. The situation seems very similar to that in the spring. The threat of a Russian invasion of Ukraine proclaimed by the US and Kiev is as unlikely today as it was then. Ukrainian forces are unlikely to pose much of a challenge for the Russian army militarily, but Russia and Putin would have little to gain politically and potentially a lot to lose. However, should Ukraine actually launch a new military offensive in the Donbass, the situation could rapidly escalate. It is unlikely that Russia would idly stand by and watch. In any case, there would be no winners in such an escalation. Meanwhile, the German regulator put certification for the Nordstream2 pipeline on hold, despite the extremely tight supply situation in Europe and skyrocketing natural gas prices. This may well be a tactical move in a multi-party conflict between the EU, Poland, Belarus, and Russia that is playing out on many fronts. It could be an attempt to persuade Moscow to exert a moderating influence on Belarusian President Lukashenko, who is allied with Russia. At the moment, he is apparently sending migrants towards Poland, where they have been trying to cross the border illegally for weeks. This in turn puts pressure on the EU and indirectly strengthens the Polish position in the conflict between Warsaw and Brussels. Lukashenko, for his part, is apparently reacting to EU sanctions and, to what he views as unacceptable attempts by the EU to interfere in Belarus' domestic affairs. Despite these events and the tense pandemic situation, the Russian stock markets remained resilient in October with a gain of around 1 % in local currency and almost 4 % in US dollars.


President Erdogan caused a new diplomatic storm at the end of October. He threatened to declare ten ambassadors (nine of them from NATO allies) persona non grata after they issued a joint statement calling for the release of a Turkish billionaire who has been imprisoned in Turkey for years. Erdogan accuses the man of being involved in the 2016 coup attempt. So far, little, if any evidence for that has been provided, and the European Court of Human Rights had already called for the man's release in 2019. This would actually be binding for Turkey, but so far Ankara has ignored the European court's order.

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President Erdogan threatens to expel 10 ambassadors

Surprisingly large interest rate cut by Turkey’s central bank

Lira falls to new record low

In the end, Turkey refrained from carrying out the threat, but Erdogan made it clear once again that he does not accept to be challenged or criticised by anyone inside and outside Turkey. The diplomatic damage caused by Erdogan's action may be temporary, but not the damage caused for the Turkish lira. Shortly before, it had come under renewed pressure after a surprisingly sharp interest rate cut by the central bank of a full two percentage points, to 16 % (with official inflation running at around 20%). The escalation in foreign policy intensified the downward momentum. At the time of going to press, the Turkish currency was trading at around 10.50 lira per US dollar - a new record low and a loss in value of over 40% since the beginning of the year alone. In recent years, only the Argentine peso has been weaker in the emerging markets universe. The statements of the central bank chief Kavicioglu, who was only recently appointed by Erdogan, were also of little help and generally raised eyebrows. He sees the current account deficit at the core of Turkey's economic problems and argued that a weaker currency would boost exports, subsequently turning the current account deficit into a surplus, which in turn would strengthen the currency and bring inflation down. The Turkish stock market rose strongly in October. However, for foreign investors, the gain of almost 9 % was almost completely eaten up by the strong devaluation of the lira (minus 7.5 %).

CE3 – Poland, Czechia, Hungary

Inflation continues to rise sharply in the CE3 countries - central banks react with accelerated interest rate hikes

Increasing inflation dynamics are currently one of the dominant topics in the three CEE countries. After a surprising interest rate hike of 40 basis points in October, another rate hike of 75 basis points followed in Poland at the beginning of November. In view of an inflation rate heading towards 7% in the meantime and an average inflation rate of 5.8% expected for 2022 (versus the central bank's target range of 1.5-3.5%), it is absolutely understandable that Poland's monetary authorities are now following suit, after the central banks in the Czech Republic and Hungary had already started raising interest rates in summer. Polish core inflation is also well above target at around 5%, and in the light of a very tight labour market there is a risk of second-round effects and, in the worst case, a wage-price spiral. A similar threat looms in Hungary, although the central bank there acted earlier. A weak currency threatens to further fuel inflation, which is currently running at about 6.5% in Hungary. This likely prompted the central bank to step up the pace of interest rate hikes. In mid-November it raised the key interest rate by 0.3% to 2.10% instead of the previous 0.15% increments. The Czech central bank also accelerated its rate hikes at the beginning of November, raising the key interest rate by 1.25% to 2.75%. The stock markets rose in Poland and Hungary in October (by 4% and 2.5% respectively), while the Prague stock index remained almost flat.

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Disclaimer This is a marketing communication of Raiffeisen Kapitalanlage-Gesellschaft m.b.H. Despite careful research, the provided information is intended as non-binding information for our customers and is based on the knowledge of the staff responsible for preparing these materials as of the time of preparation and is subject to change by Raiffeisen Kapitalanlage-Gesellschaft m.b.H. (Raiffeisen KAG) at any time without further notice. Raiffeisen KAG assumes no liability whatsoever in relation to this information or verbal presentations based on such, in particular with regard to the timeliness or completeness of the information presented and the sources of information, or in respect of the accuracy of the forecasts presented herein. Photos: Publication information Media proprietor: Zentrale Raiffeisenwerbung Publisher, created by: Raiffeisen Kapitalanlage-Gesellschaft m.b.H., Mooslackengasse 12, A-1190 Vienna Editorial deadline: 17.11.2021

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