Strong­man trades trump demo­cratic deficits in 2017

Kuwait Times - - BUSINESS -

Poland’s tight­en­ing grip on its ju­di­ciary has prompted na­tion­wide protests and threats of Euro­pean sanc­tions, but its as­set prices and cur­rency have soared this year as they have in plenty of other places where democ­racy has been eroded. The na­tion­al­ist gov­ern­ment in War­saw may have an­gered Euro­pean al­lies and sparked demon­stra­tions with bills em­pow­er­ing it to hire and fire top judges but in­vestors reckon the strong econ­omy out­weighs the risks.

The zloty and cost of in­sur­ing ex­po­sure to Pol­ish in­vest­ments barely budged and Pol­ish stocks and bonds are among this year’s top per­form­ers, with dol­lar-based re­turns of 38 per­cent and 15 per­cent re­spec­tively. Re­turns have been strong across emerg­ing mar­kets this year, but the list of top per­form­ers is pep­pered with coun­tries where lead­ers are strength­en­ing their hold on power.

Turk­ish and Chi­nese stocks jumped more than 33 per­cent, while Egyp­tian and Turk­ish dol­lar-bonds have re­turned more than 10 per­cent, show­ing that mar­kets love the eco­nomic ben­e­fits and cer­tainty that strong­man pol­i­tics can de­liver.

“Pro­vid­ing gov­ern­ments are re­spon­si­ble fis­cally they can get away with a lot of un­demo­cratic mea­sures,” said Re­nais­sance Cap­i­tal emerg­ing mar­ket fund man­ager Char­lie Robert­son. “They can pretty much do what they want to their own coun­try,” he added. “At least on a one-year hori­zon.” Of course, as the likes of Zim­babwe show, au­thor­i­tar­ian lead­ers do not guar­an­tee eco­nomic suc­cess. And in­vest­ment bets on un­demo­cratic coun­tries can turn sour as they are now in Venezuela amid Ni­co­las Maduro’s lat­est power grab and did re­cently in Saudi Ara­bia and Qatar.

Amid im­prov­ing global growth and low in­ter­est rates it is not just coun­tries where politi­cians are strength­en­ing their hold that have ral­lied ei­ther. Chile, Brazil and South Africa have all made de­cent gains de­spite po­lit­i­cal un­cer­tainty.

But such coun­tries have been far out­shone by the likes of Poland, Tur­key, Egypt, Hun­gary and China, where in some cases the re­turns on assets have been twice as strong. The main thing for mar­kets is a well-man­aged, grow­ing econ­omy where the gov­ern­ment lives within its means. Poland with ro­bust growth, ris­ing wages and con­sumer de­mand of­fers all that. “The econ­omy story (in Poland) has a lot go­ing for it, enough for peo­ple to not worry too much about pol­i­tics,” said Kieran Cur­tis, in­vest­ment direc­tor for emerg­ing mar­kets at Stan­dard Life In­vest­ments.

Tur­key, one of this year’s other top mar­kets, also has a bud­get deficit be­low 3 per­cent of GDP - as well as dy­namic growth and fa­vor­able de­mo­graph­ics.

Its stock mar­ket fell last year af­ter an at­tempted coup. A sub­se­quent crackdown by Pres­i­dent Tayyip Er­do­gan has led to tens of thou­sands of ar­rests, but Sacha Chor­ley, port­fo­lio man­ager at Old Mu­tual Global In­vestors said the coun­try’s strong fun­da­men­tals and prof­itable com­pa­nies have not changed.


Any fall­out from the demo­cratic back­slid­ing can af­fect longer term in­vestors like pen­sion funds fur­ther down the line, since bonds’ present value is linked to when they will be re­paid, which is of­ten 510 years away. Many are play­ing a much shorter-term game of a year or two though. “Are th­ese changes go­ing to af­fect fixed in­come in­vestors in this pe­riod? At least in case of Poland, you can say: not that much,” Stan­dard Life’s Cur­tis added. Some longer term in­vestors may also have in mind nearby Hun­gary.

The crit­i­cism lev­elled at Jaroslaw Kaczyn­ski, who leads Poland’s rul­ing Law and Jus­tice (PiS) party, echoes that aimed at Hun­gar­ian Prime Min­is­ter Vik­tor Or­ban some years back and who Kaczyn­ski is now close to. ‘Orbanomics’, as the poli­cies were termed, in­cluded slap­ping huge taxes on banks, en­ergy, tele­coms and re­tail­ers - of­ten for­eign-owned, an­ger­ing com­pany bosses and EU reg­u­la­tors.

But fund man­agers who stuck with Hun­gary even­tu­ally reaped out­size re­turns. Orbanomics also brought down Hun­gary’s bud­get deficit, in­tro­duced a flat 15 per­cent in­come tax rate and ap­pointed a cen­tral bank gov­er­nor who launched a huge stim­u­lus pro­gramme.

As a re­sult, growth restarted, the deficit swung into sur­plus. Since the end of 2012, MSCI’s Hun­gar­ian shares are up 40 per­cent, far out­strip­ping broader emerg­ing stocks which are only now back to their 2012 lev­els. “Try­ing to trade the in­sti­tu­tional de­te­ri­o­ra­tion in Hun­gary in re­cent years was one of the great­est loss­mak­ing trades you could have made,” said UBS strate­gist Manik Narain. “That’s cer­tainly one thing that’s en­cour­ag­ing peo­ple to sit back and be care­ful in Poland.”


Demo­cratic cre­den­tials have not just been pushed back across emerg­ing mar­kets. The 167-na­tion “Democ­racy In­dex”, com­piled by the Econ­o­mist In­tel­li­gence Unit, down­graded the United States from a “full” to a “flawed” democ­racy in 2016. Yet Wall Street has reg­u­larly hit record highs since then.

Hun­gary, Poland and Tur­key have been sink­ing deeper into the “flawed” cat­e­gory since 2015. Mean­while Rus­sia and Egypt both share the la­bel of “au­thor­i­tar­ian regime”. Coun­tries such as Sin­ga­pore and China made eco­nomic de­vel­op­ment strides with­out ad­her­ing to Western-style democ­racy but a ma­jor risk is the ero­sion of prop­erty rights a par­tic­u­lar prob­lem for in­vestors in Rus­sia.

But there are prom­i­nent in­stances this year of il­lib­eral lead­ers fu­elling mar­ket ral­lies by ram­ming through un­pop­u­lar poli­cies. Egyp­tian sov­er­eign dol­lar debt has re­turned over 10 per­cent, ben­e­fit­ing from for­mer mil­i­tary com­man­der Ab­del Fat­tah al-Sisi’s moves to float the cur­rency and cut sub­si­dies. The mea­sures, which fi­nally put Egypt on the road to eco­nomic re­cov­ery, were adopted de­spite a 20 per­cent in­fla­tion surge that hit the poor­est the most and sparked pop­u­lar anger.

“In my opin­ion, a demo­cratic gov­ern­ment would not have been able to de­liver (those changes),” said Shahzad Hasan, a port­fo­lio man­ager at Al­lianz Global In­vestors. “So this was one ex­am­ple of where a strong man was able to de­liver the painful medicine that was needed.”

An­other ex­am­ple, notes Fred­eric Lamotte, CIO of In­do­suez Wealth Man­age­ment, is In­dia. Prime Min­is­ter Naren­dra Modi, crit­i­cized as au­thor­i­tar­ian, has im­ple­mented a tax over­haul de­layed for decades by po­lit­i­cal wran­gling that could add 0.4 per­cent to the econ­omy.

Since Modi’s as­cent, MSCI In­dia has ral­lied 16 per­cent - dou­ble the gains of the broader emerg­ing eq­ui­ties in­dex. “Weak lead­er­ship will never man­age any changes,” Lamotte said.

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