Eastern Europe shows mixed development

The economies in Central and Eastern Europe have shown a very mixed development. Different monetary policies, political risks (Ukraine conflict), and the falling oil price are the main reasons.

The mixed development can be seen from various stock exchange indicators. While the stock exchanges in Poland and the Czech Republic have performed relatively in line with Western Europe this year, the indices in Austria and Hungary incurred significant losses. The Russian equity index shed more than a third of its value. Only the stock exchange in Turkey managed to stand out positively, gaining more than 30% (in euro) and thus outperforming even the US stock exchanges (+ 25.6%).

Only moderate growth outlook in CEE

The weak performance of the CEE stock exchanges (without Russia and Turkey) is largely due to worries over a possible decline of growth rates. The most recent economic data (Q3 2014) show that the region has been developing relatively well in spite of the Ukraine conflict, and Germany as growth engine of Europe seems to have been able to ward off any worse scenario as well. The development of Germany is the crucial factor for these countries.

¹⁾ Source: Bloomberg; 1 January - 22 December 2014

Special situation Russia

Russia is currently under close international scrutiny. Due to the crisis in Ukraine the market participants demand a sizeable risk premium. The current valuation of the Russian stock exchange on the basis of the PE ratio is already 40% below its historical average (on the basis of the earnings estimates for 2014).

The experts of Erste Asset Management expect a clear recession for 2015 in Russia, with a decline of GDP of roughly 4%. Given this situation, equity investors in Russia should focus on exporters, whereas pure domestic plays are facing a difficult year. The oil price of course will have a decisive influence on the share prices from here on out. In case of a further decline, the pressure on the rouble will continue, just like with other resource-based currencies. And vice versa, a solution of the ongoing conflict could trigger a quick turnaround. This means that the environment is very speculative.

Turkey will benefit from the falling oil price

Whereas Russia suffers from the falling oil price, the investment experts of Erste Asset Management expect a positive influence of this trend on the Turkish equity market. If inflation edges lower on the back of the falling oil price, the Turkish central bank might take a rate cut from currently 8.25% into consideration, which the equity market could also benefit from. The valuations on the Turkish stock exchange are not excessive in spite of the excellent performance in 2014.

Risks stemming from US monetary policy, oil price, and regional crises

Turkey has benefited from the falling global bond yields. Other stock exchanges have also been supported by this development (with the exception of the aforementioned reasons). The consensus expects that the US Fed could start increasing its interest rates from mid-2015 onwards. A strong increase in bond yields and the settlement of possible speculative positions ("carry trades") could affect especially Turkey. Russia remains very volatile and exposed to repeated short-term speculations. Along with exogenous factors such as the oil price, it is mainly political factors that influence the overall risk.

Outlook cautiously moderate

The experts of Erste Asset Management and Erste Group Research expect the East European stock exchanges to perform well in 2015, but they do not envisage any form of outperformance vis-à-vis Western Europe. Poland might surprise positively, and Turkey should benefit from the continuously falling oil price. A possible solution of the Ukraine conflict would represent a major relief for the entire region, but it is not foreseeable at this point in time.

Author:
Paul Severin
Member of the board of ÖVFA
Investment Communications Erste Asset Management
7 January 2015