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Renaissance Capital 14 January 2019

ESG

Figure 2: Strategy views (continued)

	Country		Rating Bull case				Bear case
	EM
							A slowing economy, rising inflation and higher rates in 2019, combined with ongoing sanctions risk, are likely to keep
							crossover investors on the sidelines despite attractive valuations; EM investors already OW (Russia is currently the
							biggest OW of the benchmark countries).
					The valuation underpin is strong, and Russian companies are returning cash to shareholders via dividends and		We soften our growth outlook for 2019 by 0.5 ppt (1.4%). The year-average rate is RUB67/$ We see 1) inflation
					buybacks. Russia is trading on a 12M fwd P/E of 5.5x, the lowest in EM, and 8% below its long-term average of
							picking up to 4.7% at YE19 given the VAT hike, 2) a weaker RUB and 3) normalising harvest at end-2019 and with it
					6.0x; the market offers a 12M fwd dividend yield of 7.2%, the second highest in EM on consensus figures.
							rates at 8.0% at end-2019.
					After the August sell-off, the currency is slightly cheap on our REER model.		Russia was the fourth best-performing market in EM over 2018. A lack of new stocks being listed on the market has
	Russia		N		Our long-term regression suggests the market is currently pricing in $61/bl oil, and is thus trading around fair		resulted in investor lethargy. Radical reforms are unlikely.
					value.
							Russia screens neutral on our model. Our Russia/CIS economist Oleg Kouzmin sees growth at 1.4% over 2019 (vs
					Manufacturing PMI of 51.7 in December, up from 48.1 in July (albeit down from 52.6 in November).		1.9% in 2018), while we see lending growth flat at 9%. The currency is close to fair value on our REER measure. On
					Russia’s economic reaction function to geopolitics has been to strengthen macro resilience via a floating RUB,		the positive side, we see a strong possibility of further credit rating upgrades over 2019; against that, the CBR
							surprised the market with a 25bp hike in the policy rate to 7.75% in December (though potentially the last hike of the
					inflation targeting, twin surpluses and FX reserve accumulation. Market-sentiment damaging reactions to
							cycle). While Russia may not screen so well for 2019, we believe 2020 could be substantially better, assuming no
					sanctions have been avoided.
							further sanctions.
							The fall in the oil price to c. $60/bl for Brent takes it well below the Bloomberg consensus of $70/bl for 2019,
							suggesting that EPS downgrades may be necessary
					Pakistan was the second-worst performer in EM over 2018.		The central bank raised rates 150 bpts to 10% in December 2018, which is impacting growth; consensus sees
					The currency has devalued to PKR140/$ (from PKR105/$ in December 2017) making it 9% undervalued relative		inflation reaching 9.4% in 1H19, suggesting the hiking cycle may not be over.
					to its long-term average REER on our model.		The Trump administration has voiced concerns about potential IMF loans being used to repay debts to China; the IMF
	Pakistan		N		The falling oil price could help the C/A deficit.		is proceeding slowly amid plans for greater diligence into debt sustainability.
					Valuations are looking interesting: Pakistan is trading on a 12M fwd P/E of 6.9x, the third lowest in EM, and 12%		Pakistan screens as the worst market in EM. The growth slowdown is the second worst in EM, from 5.8% in 2018 to
					below its long-term average of 7.9x; the market offers a 12M fwd dividend yield of 7.7%, the highest in EM.		4.0% in 2019E; we also forecast lending growth to halve to 8%. We expect interest to continue to rise over 2019, and
					Active EM funds have yet to engage: only 19% have any exposure (but Pakistan is just 0.04% of MSCI EM).		also forecast a downgrade to its credit rating. One comparative bright spot is the currency, which is currently 9%
					If an IMF support package can be agreed we would be more positive on reform implementation.		below fair value on our REER model.

Greece is unlikely to escape from a low-growth trap given continued austerity.

		New Democracy is leading opinion polls ahead of the October 2019 elections.
Greece	N	Strong manufacturing PMI of 54.
		Greek banks still trade at distressed valuations, given the high NPL burden (c. 40% NPLs).

At 0.2% of MSCI, Greece is easily ignored.

Though Greece scores well on our top-down model, a lack of visibility on the banks remains an issue: we don’t believe top down models capture the nuances of Greek banks’ bad debt/capitalisation dynamics.

Lack of consensus within the Eurozone on burden sharing / debt forgiveness

					Improved fiscal oil price break evens for 2019, according to the IMF: UAE ($67.4/bl), Qatar ($44/bl), Saudi
					Arabia ($73.3/bl); Kuwait breakeven remains unchanged ($47.4/bl).		In 2018, Gulf countries benefitted from pegged currencies, banks’ positive margin exposure to higher US rates and
					The MSCI EM index inclusion story for Saudi Arabia in 2019 (taking place in two tranches in May and August)		oil. Gulf countries outperformed significantly over 2018: Qatar was been the top-performing market in EM, Saudi
					and potentially Kuwait (in 2020) should drive activity and interest.		Arabia would have been the second-best market in EM had it been included, while Kuwait was the top-performing
	GCC		N/UW		IMF forecasts suggest a pick-up in growth, driven by the World Cup in Qatar, increased government spending in		market in Frontier. Only UAE stands out for having underperformed, driven by the weakness in the property sector.
					Saudi Arabia and fading fiscal headwinds in UAE (including Dubai Expo 2020 spending, though the ongoing real		UAE has de-rated from 12x fwd earnings in early 2017 to 8.9x currently. Qatar has recovered the valuation drop seen
					estate slump in Dubai continues to cause concern).		in 2017 as the economy been resilient to the breakdown of relations with neighbouring countries.
					The $ peg, which should provide some protection if the $ strengthens and EM FX sells off.		Media reports suggest that Saudi Arabia’s Public Investment Fund may have been supporting the market.
					Active EM funds are UW Qatar, UAE (in EM), so there is scope for re-engagement.

Source: IMF, Bruegel, MSCI, Bloomberg, Renaissance Capital

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Figure 2: Strategy views (continued)

	Country		Rating		Bull case		Bear case
	EM
							PMIs have been coming off their recent highs across the region, driven by weaker eurozone activity, particularly in the
							important automotive sector.
					Strong wage growth across the region (given labour shortages) is driving the consumer story and potentially		The IMF expects growth to slow given the slower eurozone economy accompanied by lower EU fund transfers for Poland
							and Hungary.
					lending growth.
					A gradual normalisation of interest rates could support bank margins.		Political risks continue. In Poland, the PiS looks likely to retain power in the general election due by November 2019:
							local election results showed narrow gains, but against a headwind of a loss of support in cities and flagging
	CE3		UW
					We like the refining sector in Poland and Hungary; of the banking sectors, Polish banks are expected to have the		momentum in rural areas. The results of the confidence vote on 12 December suggest the PiS still has a mandate for
					highest EPS growth over 2019, according to Bloomberg consensus.		its programme. Brexit diminishes the risk of a tough EU response to Hungary and Poland.
					There are no significant macro imbalances. Bank lending growth has been steady, and could have room to		Poland is trading on a 12M fwd P/E of 11.7x, and 1% below its long-term average of 11.9x; the market offers a 12M
					expand. We believe the region would be defensive in a global sell-off.		fwd dividend yield of 3.2%. Hungary is trading on a 12M fwd P/E of 10.0x, 7% below its long-term average of 10.8x;
							the market offers a 12M fwd dividend yield of 2.7%, the third lowest in EM. Czech Republic is trading on a 12M fwd
							P/E of 13.8x, 8% above its long-term average of 12.7x; the market offers a 12M fwd dividend yield of 5.7%, the fifth
							highest in EM.
	Frontier
					Vietnam could be a beneficiary of production reorienting away from China, though its exposure to global trade
					may see the economy slow slightly from 2018’s high level. An end to $ strength / CNY weakness would be a		There are risks of tighter monetary policy which could slow credit growth further (the central bank targets flat credit
					positive. Reported levels of bad debts in the banking system are falling: 1.9% at end-2018 (vs 2.0% end-2017,
							growth of 14% in 2019). The banking sector has improved its NPL ratio, but asset risks are still relevant.
					2.5% end-2016) according to the central bank.
	Vietnam		OW		The stock exchange is targeting an upgrade to MSCI EM, and is aiming to pass reforms on foreign ownership		Vietnam screens neutral on our five-factor model. Real GDP growth should remain robust in 2019E at 6.4%, but
							slightly slower than 2018’s 6.5%; lending growth will also fall slightly to 14% vs 15% in 2018 on our numbers. The
					limits for listed companies and SoEs, as well as banks and airlines by the end of 2019.
							currency is 23% overvalued on an REER basis; however, given Vietnam’s strong external position and economic
					Still one of the best long-term growth/investment stories in Frontier.		transformation, this is less of a concern. Interest rates are expected to be raised slightly, according to Bloomberg
					As a relatively large frontier market, a likely beneficiary of Argentina’s May 2019 transition to from MSCI FM to		consensus, while we do not see any changes to the country’s credit rating as likely.
					MSCI EM (Argentina is currently 17% of MSCI FM)
							The economy is in a severe contraction; industrial production fell 13.3% in November, while the IMF sees 2018
					The government is sticking to its reform programme.		growth at -2.6% and 2019 growth at -1.6%.
					Progress in bringing down inflation expectations has allowed the central bank to remove the 60% floor on		Provincial elections start in March, presidential primaries begin in August, the first round of elections are on 27
					interest rates (end-2019 inflation is expected at 28.7% according to the central bank’s December survey).		October, while the run-off is scheduled for 24 November. Support for President Mauricio Macri will depend on the
	Argentina		OW		The currency has fully adjusted to 22% below its long-term average on an REER basis.		country’s economic performance over the coming quarters: a victory for Cristina Fernandez, Macri’s populist
							predecessor would bring with it substantial risks to the current market-oriented policy.
					Argentina’s May 2019 transition to MSCI EM from MSCI FM could prompt renewed interest from GEM investors.
							Argentina screens neutral to positive over 2019. While real GDP growth is forecast by the IMF to be negative at -1.6%
					Argentina was the worst-performing market in Frontier over 2018, falling 51% in $ terms.		in 2019E, this is still an improvement on 2018’s -2.6% figure. Lending growth is forecast to fall to 20% vs 25% in
							2018. Rating agencies are likely to downgrade the country going forward, in our view.
							Source: IMF, Bruegel, MSCI, Bloomberg, Renaissance Capital

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	Country		Rating		Bull case		Bear case
	Frontier
					We believe Kazakhstan delivers one of the best macro stories in the region with high growth (3.9%/3.5% in
					2018/19E) supported by new oil fields and production.
					The macro story is supported by a floating currency, declining inflation and inflation targeting (from 6% at end-
					2018E to c. 4% target effective 2020). Potential for rate cuts (from 9.25% now to 8.75% by end-2020).		The KZT is still linked to the RUB given trade links.
					Budget discipline improved with budget rules, while sovereign sustainability looks very strong with total reserves		Oil dependence remains and is unlikely to change in the near term.
					covering 30M of imports.
	Kazakhstan		OW		Banking sector ready for growth after progress on NPL recognition after a decade of slow progress.		Bank credit growth is driven by consumers as corporates either don't borrow or have mega projects funded
							internationally.
					Ambitious reform programme including several major privatisations and relaunch of domestic capital markets		Very limited stock market in terms of liquid stocks.
					could be a positive surprise.
					Kazakhstan is trading on a 12M fwd P/E of 4.9x, the lowest in Frontier, and 24% below its long-term average of		Second best-performing Frontier market in 2018 as higher oil combined with very resistant macro backdrop.
					6.4x; the market offers a 12M fwd dividend yield of 9.0%, the second highest in Frontier.
					Kazakhstan screens positively on our model and ranks the second-best market in Frontier. The currency is the
					second cheapest in Frontier at 20% below fair-value on an REER basis.
					We believe Georgia delivers the best macro story in the region with high growth (5.2/4.8% in 2018E/2019E), a
					floating currency, inflation under control (c. 3%) and the potential for rate cuts (25 bpts this year to 6.75%). Other		Due to unfavourable seasonality, the currency could weaken during the seasonally weaker winter season for tourism.
					strengths include: 1) flourishing tourism (the number of tourists in Georgia will exceed the population by c. 1/3		Also, Georgia is exposed to contagion effects from Turkey and Russia, though to a limited extent. During times of
					this year, putting Georgia in between Switzerland and Spain on this metric; with the total amount of tourist		financial market stress, Georgia’s large C/A deficit stands out.
	Georgia		OW		receipts at 20% of GDP); 2) strong interactions with the IMF under the EFF framework; 3) improving budget		Georgia screens somewhat negatively on our model. GDP growth is set to fall to 4.8% in 2019E (from 5.2% in 2018),
					discipline (deficit at below 3% of GDP every year); as well as signs that the economy is becoming fundamentally
							while lending growth is also likely to moderate to 13% vs 18% in 2018. With only modest rate cuts (our CIS economist
					stronger and is generating more added value – i.e. an improving C/A deficit despite accelerating growth and net
							Oleg Kouzmin is looking for 25 bpts over the year) expected, we do not consider this as a significant enough change,
					exports contributing positively to growth despite recovering domestic demand.
							and there is unlikely to be much movement on credit ratings; moreover, the currency is fairly valued according to our
					Share price declines (in part on the back of reduced loan growth assumptions) have brought Georgia’s highly		REER model.
					profitable banks back to attractive valuations (c1.4x trailing book value).
							Although the economy has rebounded more than anticipated, concerns remain over Kenya’s twin deficits. It may be a
							challenge to fully lift the rate caps on the banks while they are important purchasers of government debt. Kenya suffers
							from a macro vs micro disconnect: feedback on the ground suggests businesses (particularly SMEs) and individuals are
							constrained. The corporate sector is being used as a source of revenue to help address the budget deficit via new levies
					The lower oil price projected for 2019 is positive for inflation. It will help keep inflation within its inflation target		such as the 8% VAT on fuel and the higher excise duty on mobile telephone and data services. The KES is expensive on
							our REER model.
					band of 2.5-7.5%. And it will help contain the import bill, and by implication the C/A deficit.
	Kenya		N				The vulnerable part of the economy is the fiscal side. The government needs to demonstrate that it can bring down

	Kenya is still relatively under-owned, with Frontier funds largely UW.
	Figure 2: Strategy views (continued)
	Any easing of the interest rate cap could provide upside for the banks.	the budget deficit, to restore debt sustainability. Kenya’s rising cost of debt reflects the market’s view that that the
		government needs to slow borrowing.
		The rate cap continues to dampen credit growth and undermine the conduct of monetary policy.
		Kenya is trading on a 12M fwd P/E of 7.9x, and 25% below its long-term average of 10.6x; the market offers a 12M
		fwd dividend yield of 6.9%.
		Source: IMF, Bruegel, MSCI, Bloomberg, Renaissance Capital

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Figure 2: Strategy views (continued)

	Country		Rating Bull case				Bear case
	Frontier
							Planned increases in government spending on subsidies and social programmes to quell social unrest may put
							pressure on the budget deficit as well as on the credit rating. Protests against high living costs led the King to replace
					Morocco has been a safe-haven in times of EM volatility thanks to sizable domestic pension funds and lack of		the finance minister in August, and the 2019 budget sees the deficit falling only slightly (from 3.8% of GDP to 3.7% of
					significant imbalances.		GDP, though privatisation proceeds are hoped to shrink the deficit further, to 3.3% of GDP).
					Moroccan companies can act as a gateway to high-growth francophone Africa. Strong mid-term industrialisation		Fiscal slippage on subsidies of 1.7% of GDP (vs budgeted 1.2%) saw S&P put its BBBrating on negative outlook in
	Morocco		N		story given educational levels, high investment, strong infrastructure and geographical proximity to the EU and		October.
					poor demographics in central Europe.
							While the market has de-rated, Morocco is trading on a 12M fwd P/E of 16.4x, the highest in Frontier, and 11% above
					Lower oil prices should help the economy through improved external balance and lower inflation.		its long-term average of 14.9x; the market offers a 12M fwd dividend yield of 3.6%, the fifth lowest in Frontier.
					EUR-linked currency trading around fair value. Reserves more than cover short-term debt.		Morocco screens neutral on our model. A modest GDP growth acceleration (to 3.2% in 2019E) is offset by a modest
							lending growth acceleration (to 4%). The currency is around fair value, and we see little change on monetary policy or
							credit ratings.
							The budget deficit remains a concern, bringing with it risks that the European Commission opens Excessive Deficit
							procedures; the surprise announcement of a bank tax and other sector-specific taxes undermines the attractiveness of
							the market; but shows the government may be serious about tackling the deficit.
					Overheating fears should ease as the economy slows from its above-potential growth to normal levels and as		FX reserves declined between February and August 2018 and should be monitored. Fiscal deterioration could add
					the central bank raises rates.
	Romania		N				pressure to the exchange rate and force even more tightening.
					Romania is trading on a 12M fwd P/E of 7.1x, the fifth lowest in Frontier, and 18% below its long-term average of		Real interest rates are still negative raising the prospect of rate increases in 2019.
					8.7x; the market offers a 12M fwd dividend yield of 8.7%, the fourth highest in Frontier.
							Romania screens somewhat negatively on our model. Real GDP growth should decelerate over 2019E to 3.4% (vs
							3.9% in 2018); on the positive side, lending growth should accelerate to 9% from c. 7% (though the bank tax could
							impact this). The currency is slightly over-valued (7% higher than its long-term average on an REER basis).
					Sri Lanka is trading on a 12M fwd P/E of 12.2x, and 6% below its long-term average of 13.1x; the market offers a		Ongoing political turmoil has already seen Sri Lanka’s credit rating downgraded. The prime minister has been
							reinstated, but there are still political tensions, and the potential for early elections in 2019.
					12M fwd dividend yield of 4.5%.
	Sri Lanka		N		Sri Lanka screens neutral on our model. While GDP growth should accelerate to 4.3% over 2019E (from 3.7% in		Political turmoil has already forced the IMF to put discussions relating to the release of funds on hold, adding to
							funding woes: the government has large funding requirements over 2019, including a $4.2bn expected repayment.
					2018), lending growth should fall to 11% (from c. 15%). The currency is a little over fair value, though it is the

	second cheapest in the region, while consensus expects rates to stay roughly unchanged over 2019. Credit	The currency is a little over fair value, and could be at risk of further depreciation, particularly if a political resolution is
	ratings are also likely to be unchanged following recent downgrades.
		not found, given the country’s large external funding requirements.
		Source: IMF, Bruegel, MSCI, Bloomberg, Renaissance Capital

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Figure 2: Strategy views (continued)

Country	Rating	Bull case	Bear case
Frontier

The run-up to the February elections appears peaceful. Potential for renewed reform momentum post-election.

				Banks are attractively valued, trading on FY19E P/B of 0.5x – the cheapest in our SSA coverage universe, on our		2018 was disappointing in terms of growth despite the improvement in the oil price. We expect 2% growth
				estimates. The average NPL ratio of our Nigerian coverage universe (ex – FBNH) improved marginally to 6.4% in 9M18		for 2018 and a modest pick-up to 2.5% in 2019, still below the rate of population growth. The recessionary
				from 6.9% in 1H18, and 7.2% in FY17. With oil prices above the $35-$40/bl region at which banks restructured their		environment continues on a per-capita basis.
				exposures, asset quality becomes less of a key risk. However, we note that if oil prices continue to decline, it poses a		At the NGN365/$ exchange rate used by investors, the currency is a little overvalued compared with its
				threat to the asset quality of the banks.
						long-term average; we would hope to see some flexibility introduced, though with a C/A surplus and FX
Nigeria		N		Nigeria is trading on a 12M fwd P/E of 5.9x, the second lowest in Frontier, and 31% below its long-term average of 8.5x;		reserves exceeding $42bn, we do not expect to see any change until after the elections.
				the market offers a 12M fwd dividend yield of 7.4%, the fifth highest in Frontier.		Big UW of Frontier investors has almost closed (in part because Nigeria has seen a large number of
				Nigeria screens positively on our model, scoring the best among the Frontier countries (though in absolute terms, the		deletions from the MSCI FM index).
				score is not particularly high). The main positive factors are accelerating GDP growth (to 2.5% from 2.0% in 2018) and the		Pre-election period has so far been calm, but we believe investors will await the election results before
				possibility of rate cuts according to forecasts from our SSA economist Yvonne Mhango. Lending growth, however, is likely
						reallocating.
				to remain flat, while the currency is a little overvalued (8% above its long-term average, on an REER basis). We do not
				see any change likely in credit ratings.
						The premier is seeking a third term in office and highly likely to win the election since the main opposition
						leader was declared ineligible to run. The 2014 elections saw serious protests with measurable economic
						disruption.
						Garment workers have been striking for higher wages which if achieved could increase labour costs for
				Elections appear to have passed relatively peacefully, resulting in the expected re-election of the incumbent. Assuming no		corporates.
				post-election incidents (garment workers are striking for higher wages), policy-makers can focus on delivering their		The 83.5% loan/deposit ratio target for banks must be met by 31 March 2019. 12 banks still exceeded this
				ambitious goals on industrialisation and development.
						level as of September.
				Growth is expected by the IMF to come in at 7% over 2019, similar to 2018.
Bangladesh		UW				There is a possibility of currency devaluation after the elections, given currency adjustments that have taken
				Valuations have come down: Bangladesh is trading on a 12M fwd P/E of 14.0x, the fourth highest in Frontier, and 6%		place in India, Sri Lanka and Pakistan; interest rates may also have to increase. The recent rebound in the
				above its long-term average of 13.2x – a substantial derating from its recent highs of 17x; the market offers a 12M fwd		INR might help.
				dividend yield of 2.6%, the third lowest in Frontier.		Bangladesh screens as the worst market in Frontier. GDP growth is slowing gently to 7.1% in 2019E;

lending growth should fall to 13% from 19%. The currency remains substantially overvalued: 26% above its long-term average REER, ahead of its regional peers and the most expensive currency in Frontier. We also expect interest rates to rise from their current low levels, given the general direction of tighter rates across the region.

			As a large market, Kuwait might find itself a beneficiary of Frontier funds reallocating out of Argentina (currently 17% of
	Kuwait	UW	MSCI Frontier) as it transitions from MSCI Frontier to MSCI EM. Kuwait itself is under review by MSCI for a potential
			transition to EM in 2020.
			Under owned by Frontier investors.

As with other GCC countries, our lower oil price outlook diminishes our enthusiasm. The market has been the top performer in MSCI Frontier over 2018, up 11.1%, with low foreign ownership and pegged currency keeping the market defensive. We expect Kuwait to underperform a more positive EM/FM backdrop, particularly if oil stays subdued and given friction between the legislature and executive.

Source: IMF, Bruegel, MSCI, Bloomberg, Renaissance Capital

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2018 – Nowhere to hide

Renaissance Capital

14 January 2019

ESG

You can run but you can’t hide

2018 was a challenging year for global markets to put it mildly. Of the 40 major asset classes2 we show below in Figure 3, only JPY cash provided investors with positive real dollar returns in 2018. No wonder macro hedge funds have been throwing in the towel.

Figure 3: Nowhere to hide; total returns 2018 ($) by asset class capped at -25%

5

0 -5 -10 -15 -20 -25

EM EMUSUSEM EuroUSDHYIGLocalLatinUSAsiaDMDMEM smallsmallexEmergingsmallSoft USCurncySovereign USAmericaDMcapJapanPacificcapUS-EuropeanEMAsiaEMEAFrontiercapBitcoin ( JPYDollarDMGlobalcorporateUSUSCorporateCorporateDMCorporateGlobalGovGlobalUSDPrecious EMEURGBPBrentIndustrialcashcashTreasuriesREITbondscreditREITTIPScreditcreditREITcreditGoldcreditbondsTIPSbondsequitiesmetalsFXcashcashequitiesequitiesequitiesCommoditiesEquitiesequitiesequitiesequitiesequitiesEquitiescrudeequitiesequitiesequitiesmetalsequitiescommodities77.9%)

Note: We do not see Bitcoin as an asset

Source: MSCI, Bloomberg

Of the 69 countries making up the three major MSCI global indices (World, Emerging and Frontier Markets), 66 declined in dollar terms – a 96% hit rate, representing a post-GFC high.

▪DMs declined by 10.4%, with no country index in MSCI World ending the year in positive territory.

▪EMs declined by 16.6%, with only tiny Qatar (+23.9%), which represents just 1% of the MSCI EM Index, as the sole positive performer. Only 169 of 770 full-year index constituents ended the year in positive territory.

▪FMs declined by 19.1%, with only Kuwait (+11.1%) and Tunisia (+9.8%) in positive territory. Only 23 of 99 full-year index constituents ended the year in positive territory.

▪Honourable mentions go to standalone countries such as Saudi Arabia (+15.1%) which performed well heading in to its MSCI EM Index inclusion (in two tranches, in May and August 2019). Zimbabwe3 (+119.4%), Jamaica (+23.4%) and Trinidad and Tobago (+9.5%) also showed positive performances.

EM portfolio managers can seek solace that over the course of 2018, EM performed in line with non-US global equities (MSCI World ex-US declined by 16.4%). But nevertheless, a challenging decade for EM equities, which have now suffered declines in five of the last ten years, and where the MSCI EM Index is trading back at April 2007 levels.

2 We don’t consider Bitcoin an asset class but included it for completeness.

3 In Zimbabwe, equities have acted as a currency substitute/real asset. Given currency shortages, and the widening differential between Zimbabwe’s electronic dollars and freely tradeable US dollars, international investors would not have been able to realise/repatriate this return.

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Figure 4: MSCI indices, $, rebased

Figure 5: MSCI indices, $, rebased

		EM		US			World		World ex-US
115
110
105
100
95
90
85
80
75		Mar-18				Jul-18
Jan-18	Feb-18		Apr-18	May-18	Jun-18		Aug-18	Sep-18	Oct-18 Nov-18 Dec-18	Jan-19

Source: MSCI, Bloomberg

	EM		Latin America		Em Asia			EMEA		FM
120
115
110
105
100
95
90
85
80
75	Feb-18	Mar-18	Apr-18 May… Jun-18	Jul-18	Aug-…	Sep-…	Oct-18	Nov-…	Dec-…
Jan-18										Jan-19

Source: MSCI, Bloomberg

Figure 6: MSCI indices 2018, $ – DM				Figure 7: MSCI indices 2018, $ – EM
0%				30%
-5%				20%
				10%
-10%
				0%
-15%
				-10%
-20%				-20%
				-30%
-25%
				-40%
-30%
				-50%
	Finland USA Israel New Zealand World Hong Kong Switzerland Norway Singapore Portugal Japan France Netherlands Australia Sweden Denmark United Kingdom Spain Canada Italy Germany Ireland Belgium Austria
				Qatar Peru Brazil Russia Thailand Czech Republic Hungary India Malaysia Indonesia Taiwan UAE Colombia Poland Egypt EM Mexico Philippines China Chile Korea South Africa Greece Pakistan Turkey			Saudi Arabia*
				Note: *Standalone index
		Source: Bloomberg, Renaissance Capital				Source: Bloomberg, Renaissance Capital

Figure 8: MSCI indices 2018, $ – FM

30%

20%

10%

0% -10% -20% -30% -40% -50% -60%

Kuwait

Serbia

Romania

Jordan

Croatia

Vietnam

Kenya

Estonia

Nigeria

WAEMU

Jamaica*

Ukraine*

Bulgaria* Panama*

Tunisia

Slovenia

Kazakhstan

Morocco

Lithuania

Sri

Bangladesh

Lebanon

Mauritius

Argentina

Zimbabwe*

Trinidad&

Herzegovina*&Bosnia

Botswana*

Bahrain

Oman

Lanka

FM

(+119%)

Tobago*

Figure 9: MSCI indices 2018, $ – Sectors

World EM FM

10%

0%

-10%

-20%

-30%

-40%

-50%

Healthcare

Utilities

IT

Cons Discr

Real Estate

Index

Cons Staples

Telecoms

Industrials

Energy

Materials

Financials

Note: *Standalone index

Source: Bloomberg, Renaissance Capital

Source: Bloomberg, Renaissance Capital

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Renaissance Capital

14 January 2019

ESG

▪In DMs, the top-performing markets in 2018 were Finland (-6.2%), the US (- 6.3%), Israel (-6.3%), New Zealand (-6.6%) and Hong Kong (-10.5%). The worst performers were Austria (-29.3%), Belgium (-28.6%), Ireland (-26.4%), Germany (-23.9%) and Italy (-20.0%).

▪In EMs, the top-performing markets in 2018 were Qatar (+24%), Peru (-0.3%), Brazil (-3.9%), Russia (-5.6%) and Thailand (-8.0%). The worst performers were Turkey (-43.6%), Pakistan (-37.8%), Greece (-37.8%), South Africa (-26.5%) and Korea (-22.6%). Standalone Saudi Arabia (+15.1%) is due to join the index in mid-2019.

▪In FMs, the top-performing markets in 2018 were Kuwait (+11.1%), Tunisia (+9.8%), Serbia (-0.1%), Slovenia (-3.7%) and Bahrain (-5.8%). The worst performers were Argentina (-51.7%), the West African Economic and Monetary Union (WAEMU) (-35.8%), Mauritius (-24.2%), Nigeria (-18.2%) and Lebanon (- 17.8%).

▪Sector-wise, the only EM sector in positive territory over 2018 on a total return basis was energy (+0.8%). All other sectors fell: consumer discretionary (- 33.3%), healthcare (-21.5%), IT (-20.6%), real estate (-20.5%), communication services (-17.9%), consumer staples (-15.3%), materials (-14.4%), industrials (- 14.2%), financials (-11.7%), and utilities (-6.4%).

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Why such a bad 2018?

The EM consensus has been wrongfooted for two years in a row.

Entering 2017, the concern was that newly-elected US President Trump would undermine the EM equity story by erecting trade barriers and adding late-cycle inflationary fiscal stimulus, paving the way to a potentially toxic mix of lower EM trade accompanied by higher US interest rates, bond yields and a stronger dollar. However tax cuts took until December to be passed and the feared trade war failed to materialise. The dollar had its worst performance in 13 years, while EM equities rebounded from the 20152016 China-slowdown related sell-off and a pre-US election dip to have their best year since 2009’s post-GFC rebound, rallying 34% over the year.

In the run-up to 2018, many hoped for more of the same: more rhetoric than action from the White House. Instead, policy started to be delivered. The sizeable fiscal stimulus pushed US growth up through 3% and lead to concerns that the Fed would be obliged to accelerate hikes as inflation moved up to 2.9% in July (3.0% inflation has been a strong warning signal for EM equities). US treasury yields rose from 2.0% in September 2017 to 3.2% in August 2018 in response to the recovering economy, increasing issuance to fund the fiscal stimulus and the Fed’s balance sheet unwind. From mid-April, the dollar started rallying, with the dollar index rising 9% by December as an increased interest rate differential between the US and other major currencies converged with US exporters taking advantages of tax cuts to repatriate overseas cash balances, as well as fears that rising trade tensions could lead to competitive devaluations as the US threatened to impose tariffs on nearly all Chinese exports to the US (the renminbi weakened from CNY6.3/$ to CNY6.9/$ from April to August).

Renaissance Capital

14 January 2019

ESG

Figure 10: PMIs weakening

Figure 11: PMIs – latest vs YtD peak

Japan				China		EM		Eurozone		US		World
61												65
60
59												60
58
57
56												55
55
54												50
53
52
51												45
50
49
48												40
47
	Mar-16		Jul-16			Mar-17 May-17	Jul-17		Mar-18	May-18 Jul-18
Jan-16		May-16		Sep-16 Nov-16	Jan-17			Sep-17 Nov-17 Jan-18			Sep-18	Nov-18

Latest reading YtD peak

US ISM Vietnam Nigeria* US Greece India Hungary Kenya* Brazil Russia Japan World Czech Euro area EM Indonesia China China Off. Mexico Poland SA BER Korea Taiwan Turkey

	*Whole Economy PMI.
Source; Bloomberg, Renaissance Capital	Source; Bloomberg, Renaissance Capital

Lately, the focus has moved on to the slowing global economy, where manufacturing PMI readings have been falling globally, with the global manufacturing PMI Index falling from 54.5 at end-2017 to 51.5 at end-2018. The Eurozone Index fell from 60.6 at end2017 to 51.4 at end-2018. In the US, it fell from 56.5 in April 2018 to 53.8 in December 2018 (the ISM Manufacturing PMI index fell from 61.3 in August 2018 to 54.1 in December 2018). EM has seen similar declines, where the index is just barely in positive territory, at 50.3 at end-2018, down from 52.2 in at end-2017. China’s official National Bureau of Statistics manufacturing PMI fell to 49.4 at end-2018 (from 52.4 in September 2017), a level not seen since January 2016, and the worst December figure since 2008, while new orders have declined for seven successive months. The inversion of the part of the US yield curve (five-year yields fell below two-year yields) in December added to investors’ slowdown concerns.

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Renaissance Capital

14 January 2019

ESG

Signs of tensions in the credit markets began to emerge in 4Q18. High yield spreads rose from 360 in October to 582 by December (albeit still well below peaks of 924 in 2016, 870 in 2011 and 1908 in 2008). Similarly, the JPMorgan EMBI Global Spread widened gradually over the course of the year, from 310 at the start of 2018 to 441 in early 2019 (vs peaks of 538 in 2016, 490 in 2011 and 891 in 2008). Reports of US high yield credit markets drying up caused investors to further shun risk assets during the illiquid year-end period.

4Q18 saw US equities, which had been unscathed by declines elsewhere, join the selloff. The S&P Index declined 20.2% peak to trough over October-December on an intraday basis, leading to headlines about bear markets (though close-to-close the maximum decline was just shy of a bear market, at 19.8%). Nevertheless, December’s 9.2% decline was the worst monthly performance for the S&P Index since 2009 and the worst December performance since the great depression. US investors were spooked by fears of a worsening outlook for corporate earnings (given headwinds of a slower economy in 2019, trade tariffs and the stronger dollar), accompanied by fears that a continuation of hiking/quantitative tightening by the Fed could prove excessive given the expected slowdown of the US, eurozone and China in 2019 vs 2018. 10-year Treasury yields fell back from 3.2% in November 2018 to 2.55% by early January 2019.

In summary, 2018 saw EM hit over the course of the year by: 1) rising in US rates (bond yields/Fed funds); 2) a strong dollar/EM currency weakness; 3) escalating trade tensions; 4) global/Chinese growth concerns; and 5) a sell-off in US equities. Combined, these were enough to push EM into bear market territory, with MSCI EM down 27% from its January peak by late October. Putting the decline into context, MSCI EM fell 35% during the April 2015-January 2016 China slowdown-related scare; 31% during the 2011 eurozone-related sell-off; and 18% during the 2013 taper tantrum related sell-off. The global financial crisis saw MSCI EM decline by 66%.

Figure 12: EMBI and HY spreads

Figure 13: US 10yr treasury yield (lhs), USD TWI (rhs), CNY TWI (rhs), EM FX (rhs)

JPMorgan EMBI Global spread		High yield spread

2,000												5.5
1,800												5.0
1,600
												4.5
1,400
1,200												4.0
1,000												3.5
800												3.0
600												2.5
400												2.0
200												1.5
0												1.0
2006	2007	2008	2009	2010	2011	2012	2013	2014	2015	2016	2017	2018

	US 10yr				USD TWI				EM FX			CNY TWI
												160
												150
												140
												130
												120
												110
												100
												90
												80
2006	2007	2008	2009	2010	2011	2012	2013	2014	2015	2016	2017	2018

Source: Bloomberg, Renaissance Capital

Source: Bloomberg, Renaissance Capital

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