It is difficult to remember a time when people have been more uncertain about what is going to happen in the big markets of the world. But for investors prepared to look beyond the obvious, it does not matter. Genuine emerging markets offer two re-assuring features: one, they have little correlation with the rest of the investment world and, two, they have strikingly low volatility.
It is not just the stock markets of such countries that are uncorrelated with the rest of the world. The same applies to their economies. There are no debates going on in these countries about deflation, double-dip recessions, stagflation and corporate flame-out. In many economies, the only debate is whether real growth will be 4% or 6% in 2003. Of course, emerging countries do connect with the rest of the world through trade. Most are primary producers, but the prices of the important commodities exported by these countries are either comfortably high (oil) or increasing nicely (gold, coffee, cocoa). The terms of trade for Africa and the Middle East after so many years of deterioration have improved sharply over the past year. And, if you exclude one or two lunatic outliers such as Zimbabwe, inflation is trending down and currencies are by and large stable.
Africa and the Middle East use up more than their share of space in western newspapers but most of what they report has little relevance for the prospects for investments. Nigeria has made the front page of both the London and New York Times with reports of riots in Northern cities apparently set off by outraged feelings among Nigerian Moslems when a local paper ventured that the Prophet Mohammed would marry a Miss World participant if he were alive today. Nigerian investors found these events less significant than did the editors of European and American papers; the Lagos market actually went up during the Miss World fiasco and is now breaking through to new all-time highs.
That is one of the advantages of not having foreign participants in these markets. If foreigners had been big players on the Lagos stock exchange, doubtless they would have picked up their skirts and run on the Miss World news and taken the market down 40% in the process. But the Nigerian investors who drive the Nigerian market are accustomed to riots, not unlike their Indian counterparts, and were able to treat these events with equanimity. For them, excellent half-year results are of far more importance.
Politics drive economics in the developing world. (The reverse is true in the first world.) Because of this, investors have to be alert to political change and its economic ramifications. Even at three times earnings a stock may not be a good buy if the political environment is such that there is likely to be a fundamental deterioration in the business climate and a devaluation of the currency.
But we think that in a number of countries the political signs - and hence the economic signs - are promising. Below we explain why.
The grandest sight in Kenya - Moi's back
The Nairobi Stock Exchange has been in a nine-year bear market, perhaps the longest in the world after Japan. The blame can be laid directly at President Daniel arap Moi's feet. His actions effectively strangled the country's economy and drove the energy out of Kenya's once-booming entrepreneurial sector. He also offended the donors to such a degree that Kenya had become one of the few countries in Africa on which they had turned their backs. Moi, with his free-market background, would not enjoy being bracketed with Robert Mugabe and his politburo, but the two of them have done a first rate job of crippling the two strongest and most diversified economies in sub-Sahara outside South Africa. Kenya has been a particular tragedy because, under Jomo Kenyatta, this had been virtually the only country in Africa that had maintained a mixed economy during the years of socialist orthodoxy in the sixties and seventies.
While the press was full of comments about the violence and destabilisation that would accompany the Kenyan election we took a simple view. We did not care too much whether Mr Kibaki or Mr Kenyatta Jr (a more able man than the one who has been portrayed by the press) was elected. As soon as it became certain that Mr Moi was not going to be able to find some way or re-electing himself, we knew the next President of Kenya was going to be a huge improvement.
In the event, things went better than even we could have hoped. The elections were fair and peaceful by African standards; the losers lost without crying foul and even old Mr Moi was graceful in defeat. Mr Kibaki won in a landslide.
He promises to be a good President. Despite being educated at the London School of Economics he is a sound economist and a pragmatic politician. He was one of the first to leave KANU when multi-party elections were brought in some ten years ago. He has done a canny job of putting together his cabinet. Everyone wanted to see how he was going to handle his two most rambunctious bedfellows, the hyperkinetic Raila Odinga and ex-vice-president George Saitoti. He has given them portfolios where they will be judged on results not rhetoric, Roads and Public Works for Odinga, and Education for Saitoti.
David Mwiraria, the new Finance Minister, is another professional economist; he has had a good career to date including a three-year stint at the IMF. He is a bit short on practical experience but is probably the best man to bring the donors back onside. The donors have always had a soft spot for Kenya, a cynic would say because the bar at The Norfolk is a more comfortable place from which to dole out aid to East Africa than Somalia or Burundi, but they finally suspended aid in 2000 as the Moi regime moved into the final phase of klepto-capitalism. Our guess is that, with Mr Mwiraria as the Finance Minister, it will not be long before planeloads of donor dollars are leaving Washington and Brussels for Nairobi.
Perhaps the most important change is in business sentiment. A number of bright expatriate Kenyan businessmen work in London, Johannesburg and New York. After years of depression about the state of affairs in their homeland, every one is now excited and enthusiastic about the promise their country has to offer. The next two years will see a significant reversal of the Kenyan brain and money drain. Money and talent will flow back into the country. Meanwhile domestic businessmen are thinking once again of expansion and capital expenditure. The vicious circle of the late Moi years will be replaced by a virtuous circle.
The Kenyan stock market has suffered a short-term downward reaction after the post-election euphoria, but we will be surprised if the nine-year bear market is not followed by a multi-year bull market. For investors in Africa, this is a good time to be back in Kenya as it re-enters the real world.
Zimbabwe: Democracy rules?
The Kenyan elections are the latest example of what is becoming a definite and encouraging trend in Africa: the extinction of the dinosaurs through the ballot box. It started with Diouf's loss to Wade in Senegal, since when electorates have thrown out the dinosaurs in Ghana, Madagascar and Zambia. Moi's inability to arrange for a KANU succession has sent out a powerful message to the voters of countries such as Tanzania, Uganda and Ethiopia. Democracy rules. Who knows, the message may even be getting through to Harare. Perhaps it is just coincidence that the first signs of conciliation from Robert Mugabe's ZANU came the week after the Kenya elections.
Nigeria: What's up over 100% and still going strong?
It's not surprising if investors are wary of Nigeria if they have been reading their newspapers. Riots, deaths in the street, corruption, sharia law and urban decay make good copy in the West. Nigeria moves to its own tune and, like India and Russia, it is a big, complex country with questionable table manners.
The general election was held in mid-April, Nigeria's first civilian-run presidential poll for 20 years. After a bruising primary campaign, President Obasanjo was re-nominated by his party, the PDP. His vice-president, Abubakar Atiku, the current kingmaker of the northern Muslim regions, exacted a high but unpublicised price for his support, support which effectively gave the nomination to Obasanjo. The election campaign was accompanied by allegations of vote-rigging, but in the end Mr Obasanjo was returned to the State House with more than 60% of the vote. That is an achievement. For Nigeria to return to civilian rule and to hold democratic elections was an inflexion point for Africa. To do it twice running is quite something. Nigeria, for the first time in its history as a country, is on the verge of a successful transition from one civilian administration to another. Times have indeed changed in Africa.
The economy and the currency, despite the political stalemate in Abuja and the constraining effect of Opec oil production quotas, remain stable, with the much feared election-driven collapse in macro-economic discipline failing to materialise (forecast 2003 GDP growth 4%, budget deficit 3.9%, current account deficit 1.2%). Finally, despite some hiccups, the liberalisation and restructuring of the economy has continued with a number of state-owned companies being sold.
In this environment of strong economics and weak politics Nigerian companies have continued to perform very well, buoyed by continuing strong consumer demand, and enhanced operational efficiencies due to improving infrastructure, especially the quantum improvement in communications attributable to the massive roll-out of mobile telephony. Corporate results to end-September 2002 showed very strong earnings numbers, with earnings growth averaging about 28%; the full year should be even better. Four years after the end of the economically ruinous military era, corporate activity and consumer demand is still playing catch-up to 1980s levels; the result is the current boom of which brewers, fast moving consumer goods, telecoms and financial services companies have been the major beneficiaries. Current beer consumption is about 4.5 litres a head annually; in the sixties it was over 15.
The market went through a pause in the middle of 2002; it still finished the year up 11.4%. Obasanjo's re-nomination seemed to re-energise local investors. The market broke through to a new all-time high and is already up over 5% in 2003.
Doing business in Nigeria has never been a paddle round the Serpentine, but the difficulties and risks involved are easy to exaggerate. Indeed, an apocalyptic view of the challenges the country faces works to the advantage of the companies already there for whom it serves as a welcome barrier to entry into the market. For the fact is that Nigeria presents the biggest business and investment opportunity in Africa, possibly including even South Africa. No-one questions a multi-national if it is not in Ghana; everyone does if it is not in Nigeria. Ask the people at MSI Cellular and SABMiller who do not have a presence in the country. Some of the world's biggest and smartest companies - Heineken, Unilever, Diageo, Nestle, BAT, Coca-Cola - are investing heavily (at the same time as they are milking their other African subsidiaries). These are comfortable people to invest alongside.
Mauritius: Fusing the Semdex
Have we passed an inflexion point in Mauritius? The market is certainly behaving like it. The SEMDEX (the index's name has been the only explosive thing in Mauritius for the last few years) slipped from 520 in summer 1998 to about 380 at the beginning of 2003 up from a low of 340. In the last few weeks it has shot up to 420. As you would expect, the foreign investors had all left and the domestic ones were bored with the market. Despite this decline in the market, Mauritius has continued to be one of the fastest growing countries in the world with real growth of 29.7% over the 1998-2002 period. Real GDP growth should average 5% in 2003 and 2004.
An important political and psychological landmark will be reached later in the year when Paul Berenger becomes the first Prime Minister of European origin when he replaces the incumbent Sir Anerood Jugnauth, who will move to the more ceremonial role of President. Their two parties comprise the coalition that took power in 2000; the change in Prime Minister was part of the coalition deal. It is difficult to know what, if anything, this means for the market. On the one hand the Mauritian Hindus, who make up a majority of the population, have always regarded Prime Ministering as being a job for a Hindu; the nearer the change-over, the sulkier they are getting. On the other hand the fact that the transition will probably be a peaceful affair is a positive.
The bull market that we have been waiting for has started. It has very firm economic underpinnings, though we would like to see interest rates coming down some more.
Egypt: Has the camel become a gazelle?
For a number of years many investors have felt unable to buy Egyptian stocks despite the extraordinary value they offer: yields of 10% and more are commonplace; banks sell at big discounts to book value; growing companies with dominant market shares can be bought for two to four times earnings.
The reason was that the Egyptian pound was overvalued. For years the Egyptians have seen their currency as a kind of national virility symbol. It had to be kept up at any cost. Devaluation has always been seen as an affront to national pride, just as it was in the U.K. in the 1960s and early 1990s. It is true that Egypt has been able to stumble by over the last few years, despite its overvalued currency, thanks to the USD3bn annual bung Mr Bush gives Mr Mubarak to make sure that the Egyptian leadership continues to view the 'War on Terror' and the Palestine situation in a 'responsible' manner - but the cost to the Egyptian economy has been great.
Real interest rates have had to be kept high in an attempt to bolster the pound and bankers have been threatened with the bastinado if they so much as cast a sideways glance at the dollar black market. Egyptians have been unwilling holders of their own currency. Direct foreign investors have tended to stay away despite the tempting bargains available in the corporate sector. The overall effect has been to stifle the economy and to squeeze the growth out of it. Even the Egyptian government, which for years had been cheerfully saying that their economy was growing at 5% a year while we and everyone else knew it was not growing at all, had begun to admit that maybe 5% was a touch high, er, would you believe 3%? no? well, how about 2% then?
The situation would have been very different if the currency had been allowed to find its own level. Sadly, that was never going to happen. The best anyone could expect was a continuation of the botched series of mini-devaluations, each of which would be more than a day late and a dollar short. It was inconceivable that the control-freak Egyptian government would allow the market to set the price of the Egyptian pound.
Until, at a conference on January 28, the Prime Minister, Mr Atef Obeid, slipped in, almost as an afterthought, "Oh, by the way, the pound is free to do what it likes from Wednesday. No more official rate. No guidance. Good luck, guys."
The bankers were stunned. Everyone else looked for the catch. A subsequent press release made clear that there was no catch. The Cairo investment community scratched its head and muttered: 'Was this good news? Better wait and see how it pans out.' The currency went down about 13% to EGP5.30 per USD, by which time buying orders were already coming in from foreigners who knew from experience what happens to stock markets when governments stop rigging their currencies. By the end of the week the Egyptians had decided that this was the best news since King Farouk took up residence in Monte Carlo. The market went into a buying paroxysm as the locals decided it was time to follow the foreigners, leaving most indexes up something over 20% in local currency in a matter of days.
The Governor of the Central Bank, Mr Mahmoud Abu El-Ayoun, is a model of free market reasonableness: no, he will let the currency find its own level and only interfere in times of emergency; yes, his Central Bank is in the process of becoming completely independent just like in Anglo-Saxon countries; no, no-one was underwriting the float but the Government had kept the IMF and the Gulf states informed and had received strong encouragement from them; and yes, this was part of the liberalisation process of which we will see more in coming months.
We believe the monetary policy vacuum will be filled with a combination of inflation and M2 targeting. Foreign exchange reserves peaked at USD21bn in 1997; after five years of failed policy, they are now USD14.1bn. This move should restore enough confidence to allow reserves to build from here. External debt is now down to a manageable USD29bn, most of it owed to the Paris Club. The current account is in modest surplus. The budget deficit, at 3.6% of GDP, will rise moderately to 4.0% - 4.5% as the effect of the devaluation hits. A return to economic growth will cap its rise. Most importantly, with expected inflation at a shade over 3%, real interest rates should fall sharply.
Egypt has not suddenly turned from a camel into a gazelle. The state sector still suffers from overmanning and legendary inefficiency; the devaluation will give a kick-up to inflation; a third of foreign currency earnings come from fair weather tourists. But on balance, this is wonderful news. The vicious no-growth circle into which high interest rates and underinvestment have locked the economy may now be replaced by a virtuous process of restored confidence, higher investment, lower real interest rates and a return to healthy growth.
