With third quarter GDP numbers in, Europe is looking once again like it is very far from a strong recovery. EU average growth quarter on quarter was just 0.1%. Year on year growth was - 0.4%. Next year is forecast to be better with EU average economic growth of 1.1% according to Eurostat. The problem is that the closer we get to 2014, the more we see downward revisions. By the time the actual numbers will start coming in, we will likely see growth under 1% given already established trends of constant downward revisions.
Still, at least there will be growth in 2014 for the first time since 2011. At the same time, major EU stock market indexes are up quite nicely year to date. The German DAX is up 21%, the British FTSE is up 17%, the French CAC is up 14%. Not bad for a region that is in a prolonged recession and has little prospect of a strong recovery on the horizon.
Looking east, we see a slightly different picture. We have the Polish WIG index up 15%, The Hungarian BUX is up only 2%, while Russia's RTS is down over 6%. Turkey's BIST is down over 4% as well (link to index data here). These are all economies which will most likely have a better economic growth performance for 2013-14 than the EU average. According to Eurostat data, Hungary's quarter on quarter GDP growth was 0.8%, while Poland's was 0.6%. Turkey and Russia both have far more robust growth trajectories than the EU, yet aside from Poland's stock index, all other indexes I mentioned in the Eastern Europe region are lagging far behind their economic growth prospects and very far behind the stock indexes of most West European nations. It is true that Western Europe indexes are full of international companies, or companies that do a high volume of business outside of Europe, so the stock prices of these companies will be more reflective of the global economic environment.
Companies trading on the Russian, Hungarian or other Eastern Europe stock exchanges are more local in nature and in the case of Russia, highly dependent on commodity production and price growth, neither of which are looking very promising. With that said however, given that growth in the Eastern Europe region is looking much stronger and the fact that most countries in the region have their fiscal house in order, while in Western Europe there is still a long way to go before fiscal re-balancing will be completed, it makes perfect sense to expect higher returns coming from the East European region, rather than from Western Europe.
Forex: The Hungarian Forint.
The very unfortunate thing is that there are few opportunities to invest in the region. Forex trading is always an option and I do believe that there are opportunities. The Hungarian Forint for instance was picked by Nomura as one of the best candidates for a rally at the end of this year (link). Given that it comes from one of the most aggressive Hungary bears in the past years, I think it is a credible forecast. The fundamentals show that they may be right. Hungary's central bank has been easing interest rates for over a year now and they went from record high rates to a record low of 3.20%. That process is about to end soon however, because 3% is about as low as they can go, because Hungarian Credit Default Swaps (CDS) are trading at just under 3%. Further cuts could happen if CDS will go lower gradually, because inflation is tame by historical standards, but for now, this seems to be it for the Hungarian Central Bank.
Aside from that the European Commission recently pointed out that Hungary will be one of only six countries in the European Union to be able to decrease their debt/GDP ratio in the 2013-15 period. Economic growth is picking up, going from perhaps 1% growth this year to 2% next year, which is not bad within the EU context. Hungary's trade surplus is quite impressive at EUR 847 million in September of this year according to Hungary's Central Statistical Office. On an annualized basis, it amounts to about 9% of GDP. The full year average will come in much lower but still, the positive trade balance is here to stay and even shows signs of further improvement, which is a big plus for the currency's fundamentals.
The main reason I believe Hungarian assets are undervalued is that there were too many unfounded bears around, all preaching a doom scenario since 2010. I think aside from Nomura's recent admission that their negative outlook on Hungarian assets in the past years was wrong; S&P's action in 2012 and a repeat of sorts recently is the most obviously biased in my view. They decided to downgrade Hungary's credit rating deeper into junk territory at the end of the year. That happened despite the fact that Hungary was one of only a handful of countries in the EU to achieve a budget deficit smaller than 3% (it was in fact around 2%), and achieve a drop in the debt/GDP ratio. A report released earlier this month by the European Commission confirms the fact that Hungary's healthy trajectory will remain in place.
Note: The European Commission data which I used for these graphs came out before the November 14 release of EU Q3 GDP numbers.
New numbers led to most forecasts upgrading future Hungarian GDP growth by a few tenths of a percent going forward.
As the charts above show, Hungary is a country which will outperform the EU average on all relevant measures and even the United States on some, such as budget deficit and a declining debt/GDP ratio (not shown in graph). It is a reverse of an earlier trend of under-performance which started around 2004. Furthermore, I believe there is still reason to expect further upside surprise when it comes to Hungary's overall performance. It is hard to shift from what has up to recently been very negative media and business coverage of this country, to coming around to the realization that there is a positive story that needs to be made public. That is perhaps why for the third quarter of this year, Hungary's 0.8% quarter on quarter growth rate came as a big surprise, which obliged many institutions to upgrade their growth outlook going forward.
The S&P is one of the few holdouts and there is no obvious logical explanation why they are insisting, which in this particular case calls this institution's relevance in question. They maintained their negative outlook a month ago, in other words they stand ready to deal Hungary another downgrade despite the obvious trend of declining debt/GDP ratio, as well as improving growth and steady, sustainable budget deficits.
The S&P and other institutions will likely move towards a more balanced view of Hungary gradually. It is happening already and with it so will the view of the market. That is why I believe that the Hungarian Forint is an important asset that people should keep an eye on going forward, because its value has been negatively affected by the negative coverage which is proving to be undeserved lately.
For those who do not wish to venture into forex trading (here is an option for an account which can allow people to trade the Forint: link), which is the only practical way to access Hungary as a pure play, there are few opportunities to gain significant exposure to the country. The Emerging Currency ETF (CEW) launched by Wisdom Tree was originally going to include the Hungarian Forint as part of the currency mix from all parts of the world, but it currently does not. There are also stock ETFs (link), which include Hungarian stocks, but not to a significant enough degree in my view to justify investing based solely on Hungary's fundamentals. I did however decide to cover one such ETF, the SPDR S&P Emerging Market ETF (GUR), which even though is not a significant Hungary play, provides diverse exposure to the region. (ETF: SPDR S&P Emerging Market ETF)
It may not be the ideal solution to accessing the Eastern-Central European market, but it seems to be the best choice available. I think it is by far the best way to capitalize on the faster growing part of Europe, which has been overlooked. The fund is heavily skewed towards Russia, Turkey and Poland, with holdings from these countries making up 56.7%, 18.7% and 17.3% respectively. Hungary and the Czech Republic are the only other countries of origin of the stocks in the holding which are of significance.
This ETF is up 1% year to date, which is very much out of step with the overall performance of stock markets across Western Europe, where most major indexes are up over 10% so far this year. With a P/E ratio of 7.6 versus 12.8 for the German DAX, which is up over 20% this year, as well as economic growth in the countries represented within the fund forecast to be much higher than EU average for the next few years, it is a good candidate for outperformance in my view.
The main reason for doubting the viability of the ETF is because generally speaking, if there is an economic downturn in Western Europe, Eastern Europe tends to suffer to a greater extent. On the flip side, when there is growth in Western Europe, Eastern Europe tends to grow at a faster rate. In other words, Eastern Europe is more volatile. Given that Western Europe is now on the mend and we see economic stabilization even in countries like Greece, where we can expect a return to growth in 2014 according to the European Commission forecast, we now have the signal that it is time to venture into faster-growing European assets, which up to recently were seen as more risky.
Developed world markets are now past their big recovery gain stage. More gains are probable in 2014 and beyond, but with the market already slightly overpriced (such as is the case with the United States), it does not hurt to look around and find opportunities elsewhere, where potential for gains may be higher. After the long, nasty financial crisis we experienced, it is understandable that people are more cautious, therefore understandably not very eager to part with the flight to safety strategy deployed as a response.
Given the run-up in stock prices seen in the developed world since the bottom in 2009, perhaps it is time to stop and evaluate whether or not large developed markets still present a safety play, or perhaps a play that has now been overplayed, thus no longer represents the best way forward.