Economic weakness and the resulting recession for most markets in the CEE region are no longer just expected, but rather increasingly reported and tangible. Moreover, the trouble in Euroland is not over yet, although the consensus is condensing to a view that there is at least no further massive escalation. Hence, we are more certain about where we are in the cycle and, even though one would still have to be brave to speculate on a bottoming out soon, it is more like ‘once the first snow has fallen, summer is again a bit closer....’ With this in mind, and with a strong reliance on central banks, equity markets have started to use up high risk premia. This should lend support well into 2013, before improving earnings growth is needed as a fundamental support to carry markets further.
A period of consolidation might be in the cards, while the recent increase in yields and the indicated continued shift of liquidity in search of return might be the upside risk to this view. In any case, we tend to see this as a confirmation that markets are remaining in a risk-on mode.
Earnings growth remains the weak spot. Hence, markets might appear a bit stretched. While 2013 offers some improvement in terms of growth, the earnings trend is still rather flat, offering little justification for the recent performance. However, relative to historical average valuations, most markets still offer upside from conversion to mean levels, albeit less so than earlier. Also, risk premia remain elevated, offering still substantial discounts to implied fair values. Nevertheless, we are getting closer to a point at which improving fundamentals are finally needed as a market driver.
Our allocation proposal for 1Q13 rests primarily on a further conversion to mean valuations and a continued reduction in equity risk premia. The strongest bet, based on the view that abundant liquidity is searching for still untapped potential, is our relative call for Russia vs. Turkey. While we remain a fan of the Turkish market, it might take a break, with liquidity looking for a place to rest in Russia. We remain cautious on Poland, but optimistic on Austria and CEE (Hungary remains the joker in the game, which could again turn out negatively). Assuming that the view on risk-taking stays as positive as it is, frontier markets Romania and Serbia might be interesting places to be – as long as one is aware of the risk of low liquidity.
Austria adds Semperit, Polytec and Verbund to our top picks for Jan 2013. Turkey comes in with Halkbank and Isbank; the latter was just upgraded to a top pick. Torunlar REIT and Akfen are other top choices in Turkey. Richter Gedeon and Krka constitute our top pick exposures among pharma-ceuticals, while Fondul Proprietatea completes our top ten. Expected underperformers remain STRABAG, Lotos and Philip Morris CR. Furthermore, we upgraded conwert, Palfinger and KGHM to overweight, as well as Tofas and Migros. Finally, Synthos and PKN were downgraded to underweight.