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Frontier markets (FM) are enjoying the benefits of favourable domestic conditions in 2019, but are also facing weakening external demand. Global GDP growth is projected to slow from 3.6% in 2018 to 3.3% this year, the lowest outturn expected since 2011. In turn, this has prompted G10 central banks to become more dovish. The Fed’s policy pivot during H1 and its first rate cut since the global financial crisis at its July meeting portend easier financial conditions ahead. The move has even extended beyond the G10, to several emerging-market (EM) economies.
While already low rates may cushion the effectiveness of monetary policy, the more accommodative stance should cushion the slowdown. Easing financial conditions also provide breathing space to refinance debt at more favourable rates and FM countries are likely to use this window of opportunity to raise debt. Additional support may come from expansionary fiscal policy, which a number of FM countries are implementing.
Another key factor impacting the medium-term outlook is the pace of structural reform. We continue to favour countries which implement market-based reforms, like Morocco, over those that are standing still, like Nigeria. Labour-market reform and industrial policy are likely to raise Morocco’s growth potential and reduce unemployment in the medium-term. By contrast, the re-election of President Buhari in Nigeria is a double-edged sword: it provides political continuity, but reforms are unlikely.
External accounts are broadly deteriorating in the short-term and this could be problematic under conditions of tightening liquidity. However, the current backdrop may prove less challenging from this perspective. At the same time, the trade war looms large as many FMs are dependent on trade and some are integrated into the global supply chain. Countries such as Vietnam may benefit, marginally, from the relocation of production to lower-cost countries with the required labour force and skill sets. More pertinent, we think, are the numerous trade agreements being struck in FM countries ranging from Argentina to Vietnam to Nigeria, which are supportive of medium-term growth.
A more benign global backdrop than six months ago is likely to make FM equities more attractive. To some extent, the asset class is sensitive to the path of global interest rates and may be viewed through this prism. Indeed, during the Fed’s tightening cycle (2015-18), MSCI FM rose by 13.7%, but was substantially below that of EM (31.7%). FM has only reversed part of this underperformance this year, rising by 14.7% through end-July compared to 9.2% for EM. Further upside is therefore likely given that global policy now has a significant easing bias. If the developed economies avoid entering a recession, this should provide further support.
Valuations for FM are also unchallenging on both an absolute and a relative basis. The trailing P/E is at its five-year average of 12.5. It is at a 10.2% discount to EM, which compares to a five-year average of 12.6% and 4.5% a year ago. The dividend yield of 4.2% compares to 2.8% for EM and is also attractive in the ongoing low interest rate environment.
*The publication reflects asset performance up to 31 July, 2019, and macro events and data releases up to 7 August, 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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