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Frontier markets (FM) faced a number of headwinds last year, ranging from the economic to the political. Although this is not unusual for the asset class, it came against a backdrop of tightening global liquidity, which put further downward pressure on asset prices. Tightening by the Federal Reserve and other global central banks signalled the end of ultra-loose monetary policy. At the same time, the economic and political environment was not especially benign given that exceptional US growth was partly driven by the temporary impact of fiscal stimulus, China continued to slow and US-China trade tensions escalated significantly. This heightened concern that a policy mistake (excessive tightening) could occur at a vulnerable time for the global economy.
Argentina had been the poster child in 2017 for market-based reforms in FM, but was front and centre in 2018 for the wrong reasons. Concerns over debt sustainability and shrinking liquidity led to financial instability, with the peso falling by 56% peak to trough against the US dollar, before stabilising and rallying by 10% from the September low into year-end. It took extremely aggressive action by the central bank and an IMF program to ensure financial stability. President Mauricio Macri’s administration have attempted to implement market-based reforms, but progress has been somewhat slow. As a result, market forces took over events when Macri asked the IMF to speed up its disbursements, precipitating a near 20% fall in the peso against the US dollar over two days.
However, Argentina was the exception rather than the rule in FM last year. GDP growth in major FM economies such as Vietnam, Bangladesh, Nigeria and Kenya accelerated in 2018 compared to 2017. Inflation has generally been low and controlled, while current account and budget balances are healthy and/or improving. Hence, despite the noise around FM, economic fundamentals have remained healthy.
To some extent, last year’s market narrative has reversed course in recent months due to: 1) a dialling back of the tightening rhetoric from the Fed; 2) stimulus measures from the Chinese authorities including tax cuts and monetary easing and 3) a détente in US-China trade relations. This has provided a benign backdrop for risk assets so far this year and should at least allow some time for FMs to implement reforms under less external pressure. This is particularly applicable to Argentina and could allow for continued financial stability this year.
Market performance in FM was lacklustre last year. As with other global markets, the rally in MSCI FM in January (5.7%) gave way to declines for the rest the year and resulted in a loss of 16.4% for 2018 as a whole. This was the worst annual performance since 2011 and FM underperformed both developed (-8.7%) and emerging markets (-14.6%).
MSCI Argentina (-50.8%) was a key drag on MSCI FM’s performance, with the losses somewhat justified by deteriorating fundamentals. However, many other FMs suffered losses despite improving economic fundamentals. These included Bangladesh (-14.7%), Vietnam (-12.7%) and Morocco (-7.5%). This has left FM valuations unchallenging, with the trailing P/E at a 9% discount to that of EM and only slightly narrower than the long-term average of 12% (see Chart 1). Overall, this backdrop suggests attractive investment opportunities within the asset class.
*The publication reflects asset performance up to January 31, 2019, and macro events and data releases up to February 11, 2019, unless indicated otherwise.
The information contained herein is obtained from sources believed by City of London Investment Management Company Limited to be accurate and reliable. No responsibility can be accepted under any circumstances for errors of fact or omission. Any forward looking statements or forecasts are based on assumptions and actual results may vary from any such statements or forecasts.
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