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Frontier Markets Semi-Annual Outlook

February 2020*

Slow, but Steady Progress

Frontier markets (FM) remain in a strong position to benefit from the expected uptick in global growth this year. A number of tailwinds should come into play including: 1) the trade détente between the US and China; 2) a stabilisation in business sentiment and 3) continued easy monetary conditions globally. Demand for FM exports should thus support growth and although a rebound in trade appears unlikely, stabilisation is likely to prove sufficient to boost growth from 2019.

Meanwhile, several tail risks emerged in early 2020, including tensions between the US and Iran and the spread of the coronavirus, now known as COVID-19. In both cases, aside from the absolute worst-case scenarios of outright war or a global epidemic, respectively, risks for the global economy appear manageable. In terms of COVID-19, the impact is likely to lead to a sharp deceleration in activity in at least Q1 given the impact on supply chains. However, the Chinese authorities are taking easing measures and a rebound later in the year is likely.

Price pressures are also generally benign across FM. This should help support growth. Moreover, controlled inflation means that easier global financial conditions need not elicit domestic policy tightening. At the same time, there are some exceptions where inflation is in double-digits and may accelerate further, e.g. Argentina and Nigeria, so monetary policy could be tightened in those countries.

Budget balances and debt levels are generally deteriorating as many FM economies seek to support growth and to appease an increasingly discontent electorate. Increased public sector wages are an often-used remedy. Rising debt levels are not yet problematic given easing financial conditions, but pose refinancing risks if and when there is monetary tightening. Sri Lanka’s onerous debt repayments in the coming years are one example of the problems of excessive debt load.

Meanwhile, reform momentum has slowed somewhat over the past year. This has been partly due to the election of non-reformist administrations, as in Argentina and Sri Lanka. At the same time, there are a number of examples where reforms are showing signs of progress such as: 1) Vietnam redirecting loans away from risky sectors, thereby reducing the non-performing loan (NPL) ratio and 2) Kenya revoking its interest rate cap policy.

Market Strategy

The backdrop for FM equities remains largely positive, even after a year of strong returns (see Chart 1). Consensus expects EPS growth of 10.7% yoy this year, which would be the strongest outturn in three years. This is still comfortably short of that of emerging (EM) and developed markets (DM) at 17.7% and 19.0%, respectively.

Nevertheless, FM equities retain some attractive features. Valuations are unchallenging, with the trailing P/E of MSCI FM at a 12% discount to EM close to a five-year average of 14%. The market also has a high yield, which is valuable in a low rate world. Its dividend yield of 3.8% is 1.1-1.5% points above that of EM and DM. This should be supportive for the asset class this year provided the global backdrop remains stable. Although various factors like COVID-19 and Sino-US trade tensions may derail sentiment temporarily, easy monetary and fiscal policies are likely to enable the market to look through these risks.

Chart 1: One-Year Equity Returns, % Net Total Return USD*

*MSCI indices, January 2019 to January 2020.

Source: Bloomberg

*The publication reflects asset performance up to 31 January, 2020, and macro events and data releases up to 4 February, 2020, unless indicated otherwise.

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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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City of London Investment Management Company Limited is authorised and regulated for the conduct of investment business within the UK by the Financial Conduct Authority (FCA), registered as an Investment Advisor with the United States Securities and Exchange Commission (SEC) and regulated by the Dubai Financial Services Authority (DFSA).
Registered in England and Wales No. 2851236.   Registered Office: 77 Gracechurch Street, London, EC3V 0AS, England.

© 2020 City of London Investment Group PLC. All rights reserved.